LRLCF - Estee Lauder Likely Has More Room To Fall

2023-05-04 08:46:55 ET

Summary

• Estee Lauder fell 17% after the earnings report due to a weak 2023 outlook.
• Even after the fall, the company's valuation remains expensive.
• Asia travel retail recovery is uncertain and will likely play out over multiple quarters.

Introduction

Estee Lauder ( EL ) reported a disappointing outlook during the earnings report on May 3rd leading to about a 17% share price decline. Although the company continued to see growth in most of the company's markets, Estee Lauder pointed to a weak recovery in Asia's travel retail for a weak outlook. International travel was not bouncing back as fast as the company has estimated resulting in a disappointing outlook.

Despite a 17% adjustment happening after the earnings report, I continue to believe that there are more downsides for Estee Lauder. Given the company's internal estimates, the valuation of Estee Lauder, in my opinion, is too expensive today. Further, I believe the recovery of travel retail and general foot traffic in Asia will continue to be a struggle leading to multiple quarters of weaker-than-expected growth. Therefore, Estee Lauder is a sell.

Valuation

I believe Estee Lauder, today, is too expensive. After the earnings report, the company's stock did see a massive pullback; however, when taking into account the revised earnings outlook for 2023, I do not think a significant pullback following the earnings report was enough.

In the earnings report , Estee Lauder provided a full-year outlook. The company is expecting net sales to decline about 10-12% year-over-year. This comes as a result of a "slower than expected return to growth in Asia travel retail." As a result, in the company's earnings per share outlook, Estee Lauder projected diluted net earnings per common share of about $3.29 to $3.39. Previously, about $4.87 to $5.02 net earnings per share were expected. Thus, the earnings per share outlook was revised down about 33% from the previous estimate.

Even when the earnings per share outlook was $4.87 to $5.02, the company's valuation was pricey making the current valuation even more expensive after the renewed earnings outlook. Before the earnings report, the company had a forward price-to-earnings ratio of about 49 . This level of valuation multiple has been maintained for Estee Lauder, as the chart below shows, for nearly a year. Then, taking into account an earnings revision, even after about a 17% decline, the company is trading at about 60.5 times its 2023 expected earnings.

[Chart created by author using YCharts]

Further, as the chart above shows, Estee Lauder's valuation multiple is more expensive compared to another luxury company, LVMH ( OTCPK:LVMUY ). (Please note that Estee Lauder's forward price-to-earnings after taking earnings revision into account is about 60) The stark difference is present even as LVMH is expecting a much healthier financial outlook. In terms of revenue, LVMH is expecting 11.85% growth in 2023, and for an eps estimate, the company is expecting a 28% increase. Thus, despite Estee Lauder guiding for a year-over-year decline in revenue and eps for 2023, Estee Lauder's valuation multiple is significantly more expensive than LVMH group.

[Chart created by author using YCharts ]

Further, when comparing Estee Lauder to L'Oreal ( OTCPK:LRLCY ), Estee Lauder is also significantly more expensive.

Overall, even after a 17% correction after the earnings report, because of the significant earnings revision and premium valuation, I believe that Estee Lauder continues to be too expensive today.

Slower than Expected Recovery

Apart from the current valuation, travel retail recovery in Asia may continue to lag for the foreseeable future creating a headwind for Estee Lauder. In the earnings report, the company said that they were expecting the Asia travel retail "to build gradually over the fiscal 2023 fourth quarter and the first half of fiscal 2024." However, with no clear evidence of a strong recovery, I believe it is too early to call for a road to recovery.

Asia retail in Hainan and Korea has been cited as the reason for a slowdown. So, looking at these two countries, the recovery may continue to lag expectations.

Korea is the world's biggest luxury goods spender per capita , and the recent data in 2023Q1 from Korea shows that luxury goods sales have been slowing in Korean department stores . Compared to over 30% year-over-year growth in 2022, the luxury item sales growth in all major department stores slowed to mid-single digits as the macroeconomic conditions significantly worsened. While luxury goods spending is currently continuing to show growth, I believe this may not be the case going forward. International Monetary Fund, IMF, cut Korea's 2023 growth forecast for four consecutive times in the past months to 1.5% amid the Korean economic slowdown. This comes as IMF increased the global growth forecast since 2023 showing the weakness that is unique to Korea. Thus, until Estee Lauder can show that travel retail is returning with international travel amidst economic uncertainty, I believe it may be wiser for investors to wait on the sidelines.

Further, China's international travel recovery, because of political reasons, is expected to show significant uncertainty. After banning outbound package travel, China started to resume some outbound travel starting in January 2023. From February 6th, 2023, Chinese travelers and travel agencies could book outbound travel to only 20 different countries (these countries did not include any Western countries). Then, starting on March 15th, China started to allow outbound travel to another 40 countries . This time, Western countries were included.

As seen in these policies, China continues to heavily regulate outbound international travel likely hindering the full travel retail recovery. Also, apart from the government policies, Chinese consumers have been favoring domestic or close-to-home international destinations over far international destinations in their recent travel recovery, which likely heavily impacts the full travel retail recovery.

Finally, international travel recovery even without government regulations has been slow. Using the U.S. as an example, according to the April 28th data from U.S. Travel Association, international travel has not yet recovered to 2019 levels. Although the recovery is persistent, international travel is still about 25% below 2019 levels. As such, as it is likely that China's travel regulations will hinder the strength of the recovery, the already lengthy process may take even longer in China.

Summary

Estee Lauder is expecting significantly worse earnings in 2023. As the company's valuation was arguably already expensive before the earnings report, Estee Lauder's valuation continues to be expensive likely leaving more room to fall. Further, as the Asia Travel Retail recovery is uncertain, I believe Estee Lauder is a sell.

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