Down Over 50% and Near a 4-Year Low, Is It Finally Time to Buy Estée Lauder Stock?

Estée Lauder (EL 1.70%) is a stock I've been interested in for some time. But after the company passed $130 billion in market capitalization and the stock reached an all-time high of $374.20 in January 2022, I thought it was simply too expensive. Until now.

Despite a strong stock market, Estée Lauder has lost over a fourth of its value so far this year, and is down over 50% from its all-time high. With the stock now hovering around $180 a share, the investment thesis is starting to look interesting again.

Aside from the flagship Estée Lauder brand, the conglomerate owns over 20 top cosmetic brands, including Aveda, La Mer, Jo Malone, Le Labo, M.A.C., and Tom Ford Beauty. But what separates Estée Lauder from the competition is the strength of its brick-and-mortar and online portfolio of brands across several price points in skincare, makeup, fragrance, and hair care.

However, Estée Lauder is heavily dependent on sales outside the U.S., which have been tumbling, and its skincare segment, which is facing a major slowdown in sales. Let's discuss the challenges for Estée Lauder, why the stock deserved to fall, and also why the company looks like a solid long-term investment going forward.

Image source: Getty Images.

Ongoing challenges

The cosmetic conglomerate faces declining sales, geographic weakness in Asia, and compressing margins. 

The main culprit is a decline in Estée Lauder's travel retail business. You've probably run across Estée Lauder's brands at airports, cruises, and downtown locations. The goal is to get products in front of as many potential buyers as possible. And airports provide a captive audience to do just that. 

The travel retail business was previously a growth engine. But the COVID-19 recovery is having lingering effects on the segment, especially in China and South Korea. In its fiscal Q3 2023 report, the company said it is struggling to convert travelers to consumers.

Estée Lauder's sluggish fiscal 2023 showcases one of the prevailing challenges in retail, which is that a company can only do so much with its product development and presentation. And many times, macroeconomic factors outside of a company's control are going to drive performance. But if a company has a good product portfolio and a good long-term strategy, then it should do well over time.

A down year

In its Q3 fiscal 2023 earnings announcement, the company slashed its full-year guidance and now expects to earn just $2.62 to $2.76 in diluted earnings per share (EPS), but $3.29 to $3.39 in adjusted EPS when factoring in restructuring and other charges. Still, this forecast is a major letdown compared to Estée Lauder's excellent results over the last few years. The following chart sums up the short-term challenges well.

EL Net Income (TTM) data by YCharts

A company's net income can swing widely from year to year for a number of reasons, such as write-downs, divestments, and acquisitions. But any time you see a company's margins and earnings fall off a cliff, that's usually a good indicator that something is wrong with the company, at least in the short term. 

Global headwinds

When it comes to U.S. cosmetics companies, Estée Lauder is unusual in that around 75% of its sales tend to come from outside the U.S. Its largest product category is skincare, which tends to make up well over half of its sales. The trouble for Estée Lauder is that consumers abroad are simply not buying as many luxury skin care products right now.

The company is facing a one-two punch in that its largest sales decline is coming from its most important product category, and its largest regional decline is coming from its most important region (Europe, the Middle East, & Africa).

Data source: Estée Lauder. 

In the above table, you can see that sales are declining across virtually every product category and region. And that the Americas is actually the company's smallest region by revenue. 

Why Estée Lauder is out of favor on Wall Street

Estée Lauder is heavily dependent on a strong consumer. It doesn't have the low margins to compete on price or the breadth of price points and services that a company like Ulta Beaty provides. Most of Estée Lauder's products are also not as expensive as the ultra-high-end luxury brands, which can be less impacted by the health of the consumer since they cater to the top of the market -- a cohort less affected by economic cycles.

For this reason, Estée Lauder can be a cyclical company. What makes things more complicated is the dependence on foreign markets. Estée Lauder is a victim of a strong U.S. dollar. A strong dollar effectively dilutes earnings made abroad -- earnings that make up the bulk of Estée Lauder's business.

In sum, Estée Lauder is facing a slew of headwinds that have made a slowdown inevitable.

A growing dividend 

Estée Lauder has paid a dividend every year since it went public in 1995. However, the company's dividend growth has started to accelerate in recent years. Estée Lauder has raised its dividend every year since 2010. And during that stretch, its dividend has increased seven-fold to $0.66 per share per quarter. That gives Estée Lauder stock a dividend yield of 1.5% -- which isn't stupendous, but the company's commitment to raising the dividend is a factor worth considering.

Financial health

When looking at a cyclical stock like Estée Lauder, it's important to evaluate the company's financial health by looking at the balance sheet. One of Estée Lauder's best qualities is that the company has relatively little debt on the balance sheet -- just $1.84 billion in total net long-term debt. That is very low for a company the size of Estée Lauder.

Not being dependent on debt makes it easier for Estée Lauder to handle downturns in the cycle, while also keeping interest expenses low. Companies that are heavily dependent on debt may find themselves growing that debt position during downturns, making it that much harder to rebound as the cycle improves.

Estée Lauder's path to recovery

Despite the stock's sell-off, Estée Lauder's valuation still looks inflated given the earnings decline. But management is confident that the weakness is temporary and that Estée Lauder can return to growth. 

Estée Lauder's brands are well-established, particularly in the Americas and Europe. The key to the company's sustained growth is having those brands succeed in China thanks to a growing middle class. The company's new research and development facility in China, along with its marketing efforts, illustrate its commitment to the region. 

For investors that believe in the strength of Estée Lauder's brands and the company's sustained leadership in the cosmetics industry, the sell-off looks like a buying opportunity. But until Estée Lauder's fundamentals improve, particularly in its skin care segment, the stock is likely to remain under pressure in the short term.