In the face of headwinds, the narrow-moat beauty products company enjoyed a decent quarter, but shares aren't yet attractive.
By Erin Lash, CFA | 08-19-16 | 12:03 PM | Email Article

In the face of an uncertain macroeconomic environment, unfavorable foreign exchange, and a decline in emerging market travelers, narrow-moat  Estee Lauder  chalked up a fair end to its fiscal year, posting 7% underlying sales growth, flat adjusted gross margins at 80.7%, and a 10-basis-point uptick in adjusted operating margins to 9.2%. The fourth quarter is historically the firm's weakest during the year from a profit standpoint; fiscal 2016 adjusted operating margins slipped 40 basis points to 15.5%. And despite seeing little in the way of relief from these headwinds over the course of the next several quarters, management’s fiscal 2017 guidance calls for 6%-7% constant currency sales growth and adjusted earnings of $3.38-$3.44 per share, which aligns with our forecast. As such, we don’t foresee a material change to our $90 fair value estimate (beyond the time value of money) or our long-term outlook, which calls for just more than 6% annual top-line growth and operating margins approaching 18% by the end of our 10-year forecast. However, shares trade in line with our valuation, and we’d suggest investors await a more attractive entry point.

Erin Lash, CFA, is a director of consumer sector equity research for Morningstar.

Sluggish traffic trends within U.S. mid-tier department stores--Estee derives more than 10% of its sales from Macy’s alone--as well as lower tourist traffic persist on Estee’s home turf (where sales grew at just a low-single-digit pace, accounting for around 40% of total sales). To ensure its fare is in front of consumers where they are shopping, Estee Lauder announced its intentions to extend the distribution of its product set, including selling Clinique in some Sephora outlets located inside JCPenney stores. While we regard Estee Lauder as a valued partner for retailers given its leading brand mix, we aren’t blind to the fact that efforts to expand its offerings further in mid- to low-tier department stores could ultimately eat away at the prestige (and subsequently the pricing power) inherent in its brands.

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Erin Lash, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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