Should You Bet on the Action at Elizabeth Arden?

Shares of cosmetics giant Elizabeth Arden were jolted higher in late April after South Korea's LG Household indicated that it may be taking a run at the company. Is it time for investors to pile in?

May 14, 2014 at 9:33AM


Source:  Elizabeth Arden.

Shareholders in cosmetics giant Elizabeth Arden (NASDAQ:RDEN) have been waiting for any sliver of good news to send the company's share price higher, after it has underperformed both the broader market averages and industry players like Ulta Salon, Cosmetics & Fragrance (NASDAQ:ULTA) and Sally Beauty (NYSE:SBH) over the past 12 months.  Elizabeth Arden's share price has been hurt lately by relatively weak results, as evidenced by sales and operating profit declines in fiscal 2014.

Fortunately, good news may have arrived in late April, after South Korea's LG Household indicated that it might be looking to swallow up the cosmetics giant as part of a plan to grow in foreign markets like the U.S. So, does Elizabeth Arden have some upside for investors?

What's the value?
Elizabeth Arden is certainly not the biggest fish in the global cosmetics pond, but it has built a solid niche in the celebrity fragrance arena through the licensing of brands from popular entertainers, like Taylor Swift and Justin Bieber.  While getting in bed, business-wise, with entertainers is fraught with risk, the growth in the company's base of licensee partners was primarily responsible for a upward trajectory in Elizabeth Arden's total sales and operating profit over the past few years. At the same time, management has been reducing risk by diversifying its distribution network beyond the traditional upscale department store channel, highlighted by its co-development of the Red Door Spa franchise.

In fiscal 2014, though, Elizabeth Arden's overall business has taken a step back, due to significant weakness in its North American geography, the source of nearly two-thirds of its overall sales. Digging a little deeper, the company was hurt by sales declines in its licensed products business, a trend that management attributed to the overload of product and brand choices available in the current marketplace, especially at mass merchandisers. The net result for Elizabeth Arden was a decline in its adjusted operating profitability, down 10.3%, a data point that has led management to target its finite resources on key retailer partners that are capable of driving sales momentum for the company going forward.

Looking for growth
While Elizabeth Arden could ostensibly catch a bid from one of its larger competitors, like LG Household, investors looking for growth-powered share price gains are probably going to be waiting for a while, assuming the remainder of the year follows the script of the first two fiscal quarters. Management certainly is on the case, as evidenced by the recent introduction of the Elizabeth Arden Rx line of skin care products. But the category's minimal weighting in the company's overall business mix will probably not lead to a big gain on its profit statement.

As such, investors should probably turn their attention to players in the industry that are growing in the current environment, such as Ulta. The company has been one of the runaway success stories in the cosmetics business, more than doubling its sales over the past five fiscal years, thanks to its growing base of convenient neighborhood stores that offer a broad assortment of cosmetics and personal care products at mostly value prices. Ulta has also successfully captured a portion of the upscale crowd -- the target demographic of the department stores' cosmetic operations -- by opening high-touch, in-store boutiques through partnerships with prestige manufacturers.

Similarly, Sally Beauty has powered a solid five-year run for its top line by offering a wide assortment of products from leading manufacturers, including L'Oreal and Clairol, and putting its growing base of namesake stores within a convenient distance of the vast majority of the populace. Like Ulta, Sally Beauty has taken advantage of a wildly successful loyalty program -- as evidenced by its more than 7 million Beauty Card Club members -- in order to lower its marketing expenditures and produce consistent annual improvement in its operating profitability. The net result for the company has been a solid annual uptick in its operating cash flow, thereby funding its global store-expansion plans.

The bottom line
Shareholders in Elizabeth Arden received a gift with the news of a potential merger, given its recent top-line weakness and an above-market P/E multiple that tips the scale at around 34. Unless you are a speculator, it is probably time to take a look for the exit sign.

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Robert Hanley owns shares of Elizabeth Arden and Ulta Salon, Cosmetics & Fragrance. The Motley Fool recommends Ulta Salon, Cosmetics & Fragrance. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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