Estée Lauder(NYSE: EL) reached a 10-year low after reporting atrocious first-quarter fiscal 2025 results. The stock is now down 56% year to date, and down a staggering 82.8% from its all-time high achieved less than three years ago.
Here's why this former blue chip dividend stock has fallen off the deep end, and whether its turnaround could pay off for patient investors.
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From boom to bust
Estée Lauder operates under four categories -- skin care, makeup, fragrance, and hair care. It has several internationally renowned brands, from the flagship Estée Lauder to Aveda, Clinique, Dr. Jart+, La Mer, Jo Malone, M.A.C., and more. The COVID-19 pandemic initially took a sledgehammer to Estée Lauder's results. But as restrictions eased and global economies opened up, Estée Lauder cashed in.
The company's best year ever was fiscal 2022, when it notched blowout sales and a whopping 17.9% operating margin. But page 9 of Estée Lauder's fiscal 2022 annual report was a canary in the coal mine regarding what was to come: "Our largest customer in fiscal 2022 sells products primarily in China travel retail and accounted for 13% of our consolidated net sales for fiscal 2022."
Given that Asia/Pacific made up 31% of total sales in fiscal 2022, some simple math tells investors that a single customer in China was driving a staggering 42% of Estée Lauder's entire Asia/Pacific segment.
Estée Lauder primarily relies on sales outside the U.S. Asia/Pacific was a pinnacle of strength for the company (led by China). But in fiscal 2023 and fiscal 2024, the region turned from a profitability powerhouse to a weakness.
China is far from the only country to blame for Estée Lauder's slowdown. The table shows that North America has been even worse, reporting an operating loss in fiscal 2023 and a slight profit in fiscal 2024.
Segment
Fiscal 2020
Fiscal 2021
Fiscal 2022
Fiscal 2023
Fiscal 2024
Americas Revenue
$3.79 billion
$3.8 billion
$4.62 billion
$4.52 billion
$4.58 billion
Americas Operating Income
($1.04 billion)
$518 million
$1.16 billion
($73 million)
$34 million
Europe, Middle East, Africa Revenue
$6.26 billion
$6.95 billion
$7.68 billion
$6.23 billion
$6.14 billion
Europe, Middle East, Africa Operating Income
$997 million
$1.34 billion
$1.36 billion
$843 million
$836 million
Asia/Pacific Revenue
$4.24 billion
$5.49 billion
$5.44 billion
$5.19 billion
$4.89 billion
Asia/Pacific Operating Income
$736 million
$993 million
$795 million
$824 million
$224 million
Total Revenue
$14.29 billion
$16.22 billion
$17.74 billion
$15.91 billion
$15.61 billion
Total Operating Income
$606 million
$2.62 billion
$3.17 billion
$1.51 billion
$970 million
Operating Margin
4.2%
16.2%
17.9%
9.5%
6.2%
Data source: Estée Lauder.
With the stock price down so much, investors want to know what is driving the profitability plunge and whether Estée Lauder has what it takes to turn things around.
Not all growth is sustainable
Estée Lauder is a textbook example of the pitfalls of overexpansion. The company has a highly complex business regarding product lines and how it markets and sells those products. Methods of sale include online, direct-to-consumer, third-party online malls, authorized retailer websites, brick-and-mortar retail stores, department stores, salons, and spas. With so many moving parts, Estée Lauder faces the challenge of building those distribution and manufacturing partnerships while also trying to forecast customer demand. The pandemic threw a wrench in even the best forecasters' models. But in hindsight, Estée Lauder clearly overestimated the boom in skin care and cosmetics.
Looking at Estée Lauder's figures from the table in the prior section, you'll see that its sales aren't even down that much. Rather, it's the profitability that has fallen off a cliff. When that kind of drop-off happens, it usually means a business is betting too aggressively on a specific outcome -- in this case, strong consumer spending across multiple touchpoints and all geographies. Estée Lauder set itself up for amplified gains or losses based on demand. Unfortunately, demand worked against it, which magnified operating losses.
A comparison would be a highly leveraged oil and gas company that can make bank if oil prices are above a certain level. But if prices are below that level, the losses begin to pile up -- quickly.
A turnaround play worth considering
The cosmetic industry has been hit hard by a slowdown in consumer spending and competition. Estée Lauder's bulky marketing strategy left it particularly vulnerable to a downturn -- which is why the stock has sold off in dramatic fashion.
I think Estée Lauder has fallen far enough and stands out as arguably the single most compelling turnaround play in the entire sector, but that's only because of the confidence I have in its brands.
Management has made blunder after blunder -- giving investors every reason to sell the stock. And when a stock falls by this much in a relatively short period of time, that means many investors have already gone for the exits.
Buying Estée Lauder now is a bet that the worst is over for the company, but there is little evidence that this is true. On Oct. 30, Estée Lauder appointed a new CEO and executive chair to take the company's helm on Jan. 1, 2025. On Oct. 31, the day Estée Lauder reported its abysmal first-quarter fiscal 2025 earnings, it slashed its quarterly dividend from $0.66 per share to $0.35 per share to have more financial flexibility.
There's a great deal of uncertainty facing the company right now, but the good news is that much of the damage seems to be self-inflicted. If Estée Lauder can refine its marketing and distribution strategy, right-size its supply chain, and benefit from an uptick in consumer demand thanks to lower interest rates, it could be a catalyst for return to growth. Some investors may prefer to buy the stock now, whereas others may prefer to take a wait-and-see approach to ensure the company is on the right track before diving headfirst into a falling knife.
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Daniel Foelber has positions in Estée Lauder Companies and has the following options: long December 2024 $60 calls on Estée Lauder Companies, long January 2025 $90 calls on Estée Lauder Companies, and long March 2025 $90 calls on Estée Lauder Companies. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
