Estée Lauder Companies, Inc.

Recommendation: SELL

Share Price: $82.82 (on April 19, 2015)Price Target: $73.00 (11.9% decrease)

Names of Teammates:

Kaitlyn Cockcroft

Executive Summary1. Company Description: Estee Lauder (EL) is a manufacturer and marketer of high

quality beauty and cosmetics products. EL utilizes a differentiation/brand strategy business model to take advantage of its high brand recognition and known excellence of products. EL is a largely international company and sales consist primarily of skin care and makeup.

2. Outlook for the Industry: The cosmetics industry does not highly encourage investment, but at the same time it does not discourage investment. Many of the industry’s profitability and valuation ratios are higher than that of the market. However, Porter’s 5 Forces do not encourage investment, although they do not necessarily discourage investment. There are growth opportunities for the industry, but the certainty of these growth opportunities is highly unknown.

3. Competitive Advantages and Sustainability: EL’s strengths that give it a competitive advantage in the cosmetics industry include its high quality products, high brand recognition, international basis and grasp on market demand and differentiation among brands. These strengths do seem to be sustainable; however, there are concerns over the sustainability of other strengths, particularly its international expansion, as many of the markets it is looking to expand in are volatile and uncertain.

4. Management Analysis: EL’s management is not doing a remarkable job managing the company, but EL is being managed adequately. The inventory turnover is very bad, currently at 1.93, decreasing and below the industry average of 4. On the other hand, net profit margins at hovering at 11%, slightly above the industry average and ROE is nearing 30%, above the industry average of 15%. Different management ratios give varying views on management’s job, but overall management is mediocre.

5. Growth Prospects: In five to ten years time, EL will not be growing as much as the industry, according to analysts’ projections. The next five years will only bring 9% growth for EL, whereas the industry will grow more than 14%. In the current year, EL is experiencing negative growth, and is projected to maintain this negative growth through the year, although it will begin growing again within the next year. EL’s growth prospects do not encourage investment because in the next five years, as well as in the immediate future, EL will not be growing as much as the industry, or as much as competitors.

6. Valuation: EL stock is currently overvalued. We are projecting that a fairly valued stock price is $73 - the median of our base case projections, an 11.9% decrease from the current $82.82 price. DCF models projected stock prices as low as $37, although these are artificially low due to EL’s high beta of 1.26. Even when the beta was lowered to 1.15, all of the five projections still projected a decrease in price, ranging from a 50% decrease to a decrease 15%.

We are recommending a SELL on EL stock primarily due to the largely negative stock price projections. Company management is of slight concern, as is the sustainability and certainty of future growth. Decreases in institutional ownership and the high short interest ratio also raise concerns as to the value of EL stock.

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Company OverviewEstee Lauder Companies, Inc. (EL) is a manufacturer and marketer of high-end

beauty products, notably makeup, perfume, and skin and hair care products. In 1946, Estée

Lauder and her husband, Joseph Lauder, founded EL in New York City. EL went public on

November 17, 1995. Estée Lauder died in 2007, leaving the company in the hands of

President and CEO Fabrizio Freda. Freda worked at Gucci Spa in the 1980s, afterward

transitioning to P&G. Freda was heavily involved in the beauty production division of P&G

and was a driving force in the expansion and growth of the Pantene brand line. He ended his

20 year career at P&G as president of global snacks before moving to EL. Freda currently

holds nearly 1.4 million shares of EL stock (see figure one in the appendix). William P.

Lauder, grandson of Estee and Joseph Lauder, serves as Executive Chairman of EL.

EL utilizes a differentiation/brand strategy business model. EL has positioned itself

in the upper tier of the cosmetics industry, selling expensive products at higher end

department stores. EL has further positioned itself in the upper tier of the industry by

purchasing high end fragrance brands, including Tom Ford, Tory Burch, and Tommy

Hilfiger. Products are sold for the most part at department stores, with increasing sales at

travel centers.

EL does not own or lease any specific EL retail locations. However, EL is beginning

to open stores for specific brands, namely MAC, Origina, and Aveda. EL currently owns

nearly 1,000 stores that sell EL owned brands, as mentioned above. Products are sold in

high-end retail stores, namely Sephora, Macy’s, Dillards, and Harrods. Some brands, such as

Tory Burch fragrances, are sold in Tory Burch retail stores as well as department stores.

Sales also occur in salons and travel retail outlets, such as in airports. The properties that EL

owns and leases are all manufacturing, assembly, distribution, and research and

development facilities (see figure two in the appendix).

EL has the most sales in the Americas and Europe, with 42% of sales in the Americas

and 38% in Europe. However, 51% of its operating income comes from Europe and only

30% comes from the Americas. 20% of sales and 19% of operating income is attributable to

Asia Pacific. Skin care is the highest selling product category, followed by makeup and

fragrance. Skin care makes up 43% of sales and 53% of operating income. Makeup is

responsible for 38% of sales and 39% of operating income and fragrance accounts for 13%

of sales, but only 6% of operating income. The remaining sales consist of hair care and other

beauty products (see figure three in the appendix). EL has a 5% market share in the

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cosmetics industry. L’Oreal dominates the market, with a nearly 50% market share,

followed by Unilever and P&G.

Company Management

EL has average management, with some ratios and figures pointing towards a well

managed company, and other figures pointing towards poor management, leading to the

conclusion of an averagely managed company.

Gross profit and operating profit are both trending upwards for the majority, with

gross profit reaching 80% recently and operating profit climbing to 16% in 2014. EBIT

shows the same overall trend, increasing to 16% in 2014 from 11% in 2011. Net income has

reached $1,135 in calendar year 2014, which is 10.4% of revenues for the year. Net income

trends mirror the other trends, increasing from 8% in 2011 to 11% in 2014. All of the above

ratios display an overall growth in earnings and income. However, most of these ratios and

figures dipped somewhat in calendar year 2014. Operating profit percentages dropped from

16.7% in fiscal year 2014 to 15.5% in calendar year 2014. EBIT experienced the same trend,

dropping from 16.2% to 15.1% (see figure four for common sized income statement).

Both diluted and basic EPS have experienced growth in the past several years.

Diluted EPS has risen from $1.19 in 2010 to $3.06 in 2014. There was a drop in diluted EPS

in calendar year 2014, dropping to $2.93. Basic EPS experienced the same pattern, raising to

$3.12 in fiscal year 2014 and dropping to $2.98 at the end of calendar year 2014.

On the balance sheet, the rate of change of total assets differs drastically, ranging

from a 17.9% increase during 2011 to a 0.2% drop in calendar year 2014 (see figure five for

common sized balance sheet). Cash is consistently near 20% of assets, increasing nearly 9%

per year at a rather regular rate of change. Receivables account for 17% of assets; however,

the change in receivables ranges from a 1.4% increase to a 26.7% increase. Inventory

amounts range much the same as the other assets mentioned above. Current portion of debt

increased in the second half of 2014 because of several acquisitions EL made. EL made these

acquisitions using debt, which is the reason for the increase in these numbers. Long-term

debt is hovering near 17% of total assets. The yearly change in the balance of the long-term

debt account is typically slightly negative, ranging from -0.1% to -10.4%. In 2013, the

percentage change in long-term debt was 24%. There are no drastic changes in the total

liability figures, with figures staying in the lower 50% range. The yearly change in liability

amounts remains below 10%, having many years with no significant change. EL has no

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preferred stock. Common stock and treasury stock changes Common stock amounts are

decreasing slightly to mask the exercise of options, which raises no concerns. The largest

decrease in share numbers is 1.4%, which is slightly higher, but the yearly decrease in

shares averages at 1%, raising no concern. EL uses share repurchases and treasury stocks to

mask stock option exercises and keep stock levels and EPS consistent. The difference in

basic and diluted shares averages near 2% per year, raising no concern.

Goodwill stayed fairly constant from 2011 through 2014, with increases in goodwill

occurring in the second half of calendar year 2014 and in 2010. 2010 was the most recent

acquisition for EL prior to 2014, with the acquisition of SmashBox Cosmetics. In the fourth

quarter of 2014, EL announced the acquisition of GlamGlow, Le Labo, and Rodin. These

acquisitions were made using debt and were dilutive acquisitions.

EL’s asset management ratios are mediocre and do not signal a very well managed

company. Inventory turnover is very low, dropping to 1.67 in 2014, compared to an

industry average of 4.00. There are significant concerns in regards to management’s

handling of inventory and obsolete inventory. Receivables turnover is also decreasing,

dropping from 10.4 in 2010 to 7.8 in calendar year 2014. The industry average for

receivables turnover is 10.4 and competitor P&G’s receivables turnover is 12.7. This raises

concerns for the accounts receivable account and the collectability of these receivables.

Total asset turnover is above that of the industry average. The industry average for total

asset turnover is 0.8, P&G’s total asset turnover is 0.6, so EL is significantly above both at

1.4 (see figure six for ratios). EL management is only doing a mediocre job of managing

assets, with some ratios signifying better management than others. No decisive conclusion

can be drawn based on solely these ratios.

SG&A expenses have been decreasing for the most part since 2010, although it did

increase in calendar year 2014. The SG&A expense percentage is hovering around 64%.

Although it is decreasing, it is still rather high. Gross profit margins, operating profit

margins and net profit margins are all doing rather well, with all three margins increasing

for the most part over time and all three ratios being above industry averages. These ratios

signify that management is doing a good job maintaining profitability and profit margins.

EL’s ROA is hovering around 15%, increasing yearly and above the industry average and

competitor’s figures. BEP is nearing 22%. BEP is higher than ROA because ROA is biased

against companies with debt, so BEP is unbiased against capital structure. EL does have

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some debt, although small amounts of debt, so BEP is higher. ROE is regularly near 30%,

above that of the industry, market, and competitors. ROE is well above 13%, but it could be

artificially inflated some because ROE can be raised with debt, but ROE is not a concern at

this time. The DuPont ROE is also increasing, averaging 31%. The equity multiplier is not

increasing, so the DuPont ROE is increasing due to higher profit margins and asset turnover,

which is good (see figure six for all ratios).

All of the above asset management and profitability ratios indicate that management

is doing a mediocre job managing the company. Asset management ratios do not portray

management as doing a good job; however, the profitability ratios are high, so management

is doing some things right with the company.

Liquidity & Solvency

EL’s liquidity and solvency ratios indicate that EL is very likely to stay in business, as

it has no immediate cash problems. EL has rather low debt levels and could easily take on

and handle more debt. EL’s current ratio is 2.35, well above 1.5. The quick ratio is 1.81,

above the industry average of 0.5. These two ratios indicate that EL has no immediate cash

problems that will bring into question its ability to stay in business.

EL has little debt, less than 20% of total assets on the balance sheet. EL’s total debt

ratio, debt equity ratio, and equity multiplier are all very low, meaning EL has little debt.

The debt to equity ratio for EL is currently 0.36, nearly half that of the industry, and

significantly less than that of its competitors (see figure six for ratios). EL’s TIE ratio

increases from 20 to over 30, way above the industry average, competitors’ TIE, and the

needed threshold of seven. This high TIE ratio means that EL is more than capable of

handling its debt and the debt’s associated interest obligations. The debt/EBITDA ratio

ranges from 0 to going slightly negative at times, which is very low. EL is more than capable

of handling its debt and could easily take on more debt, which could be a good thing,

particularly for shareholders. By taking on more debt, EL would be able to increase

dividends or share repurchases and have a long-term interest obligation, which would give

management more responsibility for the cash assets on the balance sheet.

Primary Industry Analysis

The cosmetics industry is a segment of the personal goods industry. As of 2008, the

value of the cosmetics industry was $245 billion. The most popular and widely sold items

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within the cosmetics industry include skin care and hair care, followed by makeup and

perfumes. The cosmetics industry is dominated by a limited number of large, international

corporations, including Estee Lauder, Revlon, L’Oreal, P&G and Unilever (see exhibit eleven

for further industry info and figures), which are EL’s competitors. EL utilizes a

differentiation/brand strategy business model because its products are high-scale, high-

cost products, many bearing designer names.

EL’s ROE, ROIC, profit margin percentage, and operating profit percentage ratios are

all higher than that of the market, promoting a sustainable competitive advantage for EL

(reference exhibit six for ratio breakdowns). EL falls within the top 20% of companies in

terms of profit margin percentage. EL is a company that is in the stabilization and market

maturity phase of the industry life cycle, growing slightly below the market in the future.

The personal products industry is in favor currently compared to the market.

Michael Porter’s 5 Forces yield the conclusion that this industry mildly discourages

investment.

1. Competition Levels: High: Discourages Investment – Competition in the

cosmetics industry is rather high, particularly because there are only a small number of

large corporations that make up the majority of the market share. Net profit margin for the

industry is 10.7% and margin the market is 9%. The industry average ROIC is 16.8% and

the market average of 11.3%. Profit margins are higher in the cosmetics industry than in

the market as a whole and ROIC is also higher in the cosmetics industry. The comparison of

market to industry in the case of these two ratios does not necessarily discourage

investment, but the levels of competition are high in the industry, particularly because of

the small number of companies that dominate the market share.

2. Threat of new entrants: Low: Encourages Investment – The threat of new

entrants is low in the cosmetics industry because substantial capital is needed in order to

break into the industry, creating a significant barrier to entrance. The cosmetics industry is

a capital intensive industry, with significant capital needed to continue research and

development and create new products that can keep a company competitive.

3. Threat of substitute products: High: Discourages Investment – The threat

of substitute products is high in the cosmetics industry because there are so many brands

and so many choices. Although the industry is dominated by a handful of large corporations,

each of these corporations owns many brands, such as EL, whom owns numerous brands,

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such as Clinique, MAC, Tory Burch, etc. Porter’s analysis states that a low threat of

substitute products is preferable, so this factor discourages investment somewhat.

4. Bargaining power of customers: Medium: Neutral – Although EL is sold in

thousands of locations across the world, the majority of sales are done in department

stores. According to exhibit three, 50% of EL sales are done in both international and

domestic department stores. These 50% of sales are fairly concentrated in specific

department stores, such as Macy’s, Dillard’s, Sephora, etc. The bargaining power of these

customers is higher than desired.

5. Bargaining power of suppliers: Low: Encourages Investment – The

bargaining power of suppliers is low. EL does not rely on any one supplier extensively, and

there is no ingredient or product that is in short supply, which could give a supplier higher

bargaining power.

As a whole, the cosmetics industry does seem to slightly encourage investment. The

cosmetics industry has less debt than the market and yields higher TIE ratios. Many of the

profitability ratios for the industry outperform those of the market. The cosmetic industry’s

net profit margin averages 10.7%, compared to the market’s average of 9%. ROIC is also

higher for the cosmetics industry than for the market. The valuation ratios indicate that the

industry is currently in favor with the market.

I believe that the cosmetics industry overall does encourage investment, primarily

because of its high profit margins. I believe that the cosmetics industry will experience

moderate growth in the next year, with more international growth expected in the medium

term five-year range. The cosmetics industry is currently expanding into Asia, and this

expansion will continue in the immediate future, expanding the industry. In the next five

years, the cosmetics industry will be continuing to expand its presence in Asian markets, as

well as attempt to grow in the Middle Eastern markets. The cosmetics industry, EL included,

is projecting in the range of 5% to 10% growth, and much of this growth is coming from

expanding international markets. I have concerns as to the stability of this growth because

of the volatility of the Middle East, as well as the complexity of Asian markets. Revlon had to

pull out of China in 2014, so it is not a guaranteed growth opportunity. Cosmetics

companies will need to adapt its products to the Asian consumer and continue to develop

new products that meet these consumers’ tastes and demands. EL is developing its water

lotions segment because Asian consumers like a lighter weight skin treatment, so EL does

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recognize that products must be adapted to its consumers, but the market as a whole is still

uncertain.

I do not expect EL to significantly increase its market share in the near future. There

may be some possibility for increase because Revlon was unable to capture the Chinese

market, so EL might be able to increase its market share in part because of Chinese sales.

Overall, I do not expect EL to be able to significantly increase its market share. I have

concerns that EL will be able to grow in the future, particularly at the rate in which it and

the cosmetics industry are hoping. The quarterly breakdown of revenue and net income

(see exhibit twelve) show that from December 2013 to December 2014, there was minimal

change in any of the key categories and ratios, signifying minimal change and growth

overall for the company, particularly because these quarterly trends give a more accurate

picture as to the year to year growth experienced.

The cosmetics industry does not highly encourage investment, but at the same time

it does not discourage investment. Many of the industry’s profitability and valuation ratios

are higher than that of the market. However, Porter’s 5 Forces does not encourage

investment, although at the same time it does not necessarily discourage investment. There

are growth opportunities for the market, but the certainty of these growth opportunities is

highly unknown.

Competitive Advantages

Some of EL’s strengths are that it is a high quality cosmetics brand, and the brand is

highly recognizable as a high end cosmetics brand (see exhibit thirteen for full SWOT

analysis). EL has a strong international basis, with over half of all sales occurring abroad,

particularly in Asia and Western Europe. Thus far, EL has been able to capitalize on

international growth, showing success in Asia and South America. This success can be seen

in its financial statements. The European market makes up 38% of sales and 51% of

operating income. This difference in sales and operating income percentages can be

attributes to differing costs of products – Europeans tend to purchase higher prices

products and brands from the Estee Lauder line.

Another one of EL’s strengths is its grasp on market demand and differentiation

among brands. EL owns 27 brands excluding the Estee Lauder brand and each of these

brands targets a slightly different market segment. The Estee Lauder brand is a more costly

brand and is thought of typically being used by older women. Smashbox and MAC cosmetics

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brands are less costly options and are used by younger, more fashionable consumers. EL

owns so many brands with different target markets that EL is able to attract a variety of

consumers with different needs and different budgets. This strength makes EL unique from

its competitors because EL is able to attract so many potential customers.

EL’s competitive advantages do, for the most part, seem sustainable. EL will remain

a high-end cosmetics company with superior brand recognition, making its moat quite wide.

Estee Lauder is a highly known name in the beauty industry, as are many of its subsidiaries.

Concerns do arise from EL’s international advantage because there is uncertainty and

volatility in numerous markets EL is looking to expand to, with this expansion constituting a

significant portion of its future projected growth.

EL does have several strengths that give it a competitive advantage within the

cosmetics industry. These strengths do seem to be sustainable; however, there are concerns

over the sustainability of some strengths, particularly its international expansion, as many

of the markets it is looking to expand in are volatile and uncertain. Overall, EL has

competitive advantages that are unique from its competitors.

Accounting Issues

There is no evidence of any financial problems or required restatements of financial

documents. EL’s financial statements appear legitimate and reliable. There are no concerns

regarding the relationship between cash flows and accounting numbers. Net income for

calendar year 2014 was $1,135 and cash flows for the same time period were $1,747. Cash

flows are higher than net income, giving investors confidence in the legitimacy of the new

income numbers, as net income is easier to manipulate the cash flows.

Share Repurchases, Options, & Dividends

EL does not have a large options program. The percentage difference between

diluted and basic shares outstanding, which can be highly attributed to options programs, is

hovering around 2%. There is no concern that management is taking too much from

shareholders. EL is repurchasing shares and treasury share dollars are changing as well. EL

is utilizing a combination of share repurchases and treasury shares to mask stock options.

The repurchasing of shares is attributable to EL covering up the effects of stock option

programs. EL’s options program, as well as share buybacks, encourages investment.

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The dividend yield for EL is rather low at 1.2%, and the DPR ratio is also rather low

at 29%. The low dividend yield could potentially discourage particular investors,

specifically the elderly, who live off of dividends. However, the DPR ratio is low, indicating

the current dividends are stable and likely to increase, which does seem true as the past five

year dividend growth percentage is 29%. Currently, the dividends of EL mildly encourage

investment because they have no significant problems and potential for growth. However,

one concern is that during 2011, dividends were cut by over half, and after much research

and analysis of the financial statements, no clear reasoning can be found for this dividend

decrease, which does raise concerns.

Insider & Institutional Ownership

The current levels of insider and institutional ownership do not pose great concern

for investors; however, the recent changes in these levels raises considerable red flags in

regards to EL stock. EL’s insider ownership currently stands at 2.97%, which is a good

amount because it gives employees skin in the game, but not so much so that they cannot be

removed from the company. However, as shown in exhibit seven, there are numerous

transactions that have occurred in the past six months in which EL management sold their

stock. The insider selling of stock, non option related stock sales, is a concern because

management knows a company best. For management to sell their stocks signals to

investors that management does not even want to keep their ownership in the company, a

very bad sign to investors. In exhibit seven, there are no recent insider non-option

purchases shown, yielding the conclusion that management feels the stock is overvalued.

Although insider ownership is reported at 2.97%, the Lauder family holds nearly 90% of all

EL stock, a concern because of their power over the company and over management.

Institutions currently own 90.1% of EL stock, which is a decrease of 4.98% from

2013. Although the institutional ownership percentage is within the acceptable range, the

drop in institutional ownership is a concern. Institutions think that EL stock will not

perform with the market, but perform less than the market, which is why they are selling.

Insider and institutional ownership is a concern for EL stock, signaling that the stock

may be overvalued and discouraging investment. Top level management are selling their

stock because they likely feel as though it is overvalued, and institutions are no longer

keeping such large stakes in EL stock because they do not think it will perform as well as the

market. Insider and institutional ownership discourages investment.

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Key Risks

EL currently faces currency risks associated with both Europe and South America.

The Euro is performing poorly right now, and foreign currency exchange risks are a risk

that EL is constantly faced with. In addition to European and Asian currency exchanges,

Venezuelan inflation and controls on currency exchange forced EL to record a $38.2 million

charge on its balance sheet to revalue assets.

Considerable portions of EL business is already conducted overseas, with America

only constituting 30% of net income (see exhibit three). The majority of EL’s future growth

and expansion plans will be conducted overseas, including expanding its presence in the

Asian markets as well as growing in the Middle East. Both of these geographic regions are

unpredictable regions and do not leave the investor confident in future growth. The Middle

East is a politically unstable area and growing operations in the Middle East could be costly,

particularly if EL will have to pay bribes and excessive fees to corrupt governments in order

to operate. The Asian market is also a dangerous market, although EL has shown signs of

succeeding thus far in the market. Revlon had to pull out of the Chinese market in 2014, so

EL must continue to innovate and adapt its products to fit the tastes of the Asian consumer.

As discussed with Michael Porter’s 5 Forces, EL is rather concentrated with a small

number of retailers. Becoming too concentrated with a single retailer is a significant risk for

EL, as well as increasing the bargaining power of customers. Any disruption in production

or distribution to these large retailers is another key risk for EL, as it is a manufacturer and

seller of cosmetics. Any disruption in either of these processes could cost the company time,

money, and potentially customers.

During the fourth quarter of 2014, EL acquired GlamGlow, Le Labo, and Rodin.

These are the first acquisitions for the company since 2010. These acquisitions are all very

recent, so these acquisitions have not yet proven to be success or not. However, acquisition

risk is a key risk for EL. Acquisition risk is also a factor in terms of international expansion

for the company.

Lauder family influence is a key risk for EL. The Lauder family owns nearly 90% of

all EL stock, giving them significant influence over the company and company management.

The family owns 86.7% of stock and there are three Lauder family members on the Board of

Directors. EL is essentially at the whim of the Lauder family, which could be a huge risk for

the company.

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EL does have one pending litigation case as of the end of calendar year 2014.

Darphin Corporations has sued EL, claiming that Darphin is owed more money, as part of

the sale of Darphin to EL. Potential litigation is a concern for EL, primarily in regards to its

product safety. A key risk for EL is the potential for a dangerous product, one that harms

consumers.

EL has several key risks, including international risks and international exchange

fluctuations, acquisitions risks, Lauder family ownership, and litigation. The high levels of

Lauder family ownership is one of the largest risks, as well as EL’s involvement in

international markets and the volatility of said markets.

Additional Information

EL has a current cash per share of 3.63. Cash per share has grown at a rate near

15% per year for the past several years, which is encouraging to investors because it

indicated dividend growth potential.

EL’s short position is of some concern and mildly discourages investment. The short

interest as a % of float is 2.7%, which is within the 2-3% acceptable range. However, the

short interest ratio is 3.5, above the preferable 2-3 range. Although it is not above 5, which

is cause for significant concern, this is a red flag because a high short interest ratio indicates

that professionals are betting the stock price will fall.

The most recent quarter, quarter four of calendar year 2014, shows a change in

some trends, primarily due to the acquisitions that took place. EL acquired three companies

during this quarter of 2014, having not acquired any companies since 2010. From quarter

three to quarter four of 2014, numbers did increase, including profit margins, and expense

margins decreased. This is to be expected, as EL is a cyclical retail company, with a majority

of sales coming in quarter four. When compared to quarter four of 2013, there is nearly no

change. Net profit margins did not change at all from quarter four of 2013 to quarter four of

2014. This is a concern and could lead to an investor being discouraged because looking at

quarterly trends is one of the best ways to gauge accurate growth, and these quarterly trend

analyses indicate that limited growth is occurring.

Growth Prospects

In five to ten years time, EL will not be growing as much as the industry, according

to analysts’ projections. The next five years will only bring 9% growth for EL, whereas the

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industry will grow more than 14% (see exhibit twelve). In the current year, EL is

experiencing negative growth, and is projected to maintain this negative growth through

the year, although it will begin growing again within the next year or more. Sales have

increased from 2011 to 2014, although sales decreased by 0.2% in calendar year 2014. Net

income displays the same trend, increasing nearly 20% per year, until calendar year 2014,

when net income dropped 6%. Analysts are projecting that sales will increase nearly 5%

again next year, although sales will continue a negative growth pattern for the remainder of

the year. EL’s competitor, Coty, has also experienced negative sales trends this year, but

Coty is projected to increase sales overall by 15% this year, compared to EL’s negative sales

trend this year. EL’s growth prospects do not encourage investment because in the next five

years, as well as in the immediate future, EL will not be growing as much as the industry, or

as much as competitors.

Valuation

The valuation ratios for EL stock conclude that the stock is currently in favor. The

P/E ratio is 26.0. The industry average is 21.1 and the market average is 19.0. The forward

P/E for EL is 29.7, meaning that more growth is expected in the coming years. The P/CF

ratio is not in favor. EL’s P/CF ratio is 24.4 and the industry is 37.1, although it is in favor

compared to the market, which has a 23.3 P/CF ratio. The P/B ratio is in favor compared to

the market and industry. The P/S ratio is in favor to the industry (see figure eight for

valuation ratios).

Three out of the four valuation ratios are in favor, signaling that the stock is in favor.

The P/E ratio is quite in favor, being 26.0 compared to the industry average of 21.1 and the

market average of 19.0. The current P/E is 23% above industry average and 37% above

market average. The P/CF ratio is 34% below the industry average and 5% above market

average. The P/B ratio is 54% above industry average and P/S is 25% industry average. EL

stock is highly in favor with the market, which discourages a buy recommendation.

Stock Price Projections

Based on several methods of stock price projection, the projected EL stock price is

$73, an 11.9% decrease from the current stock price (as of 4/19) of $82.82. Of the five

different projection methods used, the two DCF methods yielded the lowest projected stock

prices. The DCF Equity model projected a $44 stock price and the DCF Enterprise projected

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a $37 stock price. The DCF Equity model is projecting a 47% decrease in price and the DCF

Enterprise model is projecting a 55% decrease in stock price (see exhibit nine for all stock

projection models). One item to note with the DCF models it that EL has a high beta, 1.26, so

the DCF projections will be artificially low due to the high beta.

The three multiples models used yielded higher projected stock prices, although

most projections still call for a drop in stock price. The P/E model projected a $73 stock

price (including cash), for an 11.9% decrease in price. The P/FCF model projected a $78

stock price for a 5.8% decrease in price. P/S was the only model to project an increase in

stock price, a projected price of $84 for a 1.4% increase.

The base case projections, as described above, using the beta of 1.26, yielded an

average projected stock price of $73, an 11.9% decrease from the current price (reference

exhibit ten for sensitivity tables). Using the DCF projection models and analyzing stock

projections based on optimistic and pessimistic cases, the stock price ranged as low as $38

to as high as $61. Although an optimistic case was analyzed, with growth increased

substantially, stock projections only rose to $61 under the DCF model. Using a midpoint

beta of 1.150 in the stock projection models, stock prices still showed a significant decrease,

with the projected price being $53.

Nearly every single stock price projection, using several different models and

varying growth rates and betas, shows a significant decrease in EL stock price. The

significant decreases in stock price signify that the stock is currently overvalued.

Conclusion

Our recommendation for EL stock is a sell because of several key factors, some of

which are detailed in the below pros and cons list, with cons greatly outweighing pros.

Management is doing a mediocre job managing the company, with profitability ratios

looking good overall, but inventory turnover cannot be ignored. In the current year, EL is

experiencing negative growth, and is projected to maintain this negative growth through

the year, although it will begin growing again within the next year or more. EL’s growth

prospects do not encourage investment because in the next five years, as well as in the

immediate future, EL will not be growing as much as the industry, or as much as

competitors. EL is in favor with both the market and the industry, as seen with the valuation

ratios. EL stock is highly overvalued, having a current stock price of $82.82; however, using

several projection models and variations of such models, $73, an 11.9% decrease from

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current stock price, is a fairly valued price for EL stock. We predict that soon the market will

realize EL stock is overvalued and stock price will decrease, propelling our sell

recommendation.

Pros: Good valuations ratios

Good profitability ratios

Global expansion plans

515

Sources

1. Elcompanies.com2. Wikipedia.com3. esteelauder.com 4. http://atlas.equilar.com/wa/app/wealth_details.jsp?executiveId=672604 5. http://www.bidnessetc.com/subindustry/cosmetic/overview/ 6. http://atlas.equilar.com/wa/app/wealth_details.jsp?executiveId=672604 7. Finance.yahoo.com8. http://www.forbes.com/sites/greatspeculations/2015/01/05/reasons-behind-

estee-lauders-sudden-acquisition-spree/9. http://brandongaille.com/26-cosmetics-industry-statistics-and-trends/

http://en.wikipedia.org/wiki/Cosmetics#Cosmetic_industry10. http://www.gurufocus.com/term/per%20share_freecashflow/EL/Free%2BCashflow

%2Bper%2BShare/Estee%2BLauder%2BCos%2BInc

11.

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Exhibits

Fabrizio Freda, CEO – Estee Lauder stock ownership

Freda owns, according to this chart, 1,392,543 shares of EL stock, including stock held, exercisable and unexercisable options. The total of this stock is

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Estee Lauder Locations by

Region

Number

Owned

Number

Leased

Percent

Owned

Percent

Leased

The Americas 4 8 33% 67%

Europe, Middle East & Africa 4 6 40% 60%

Asia Pacific 0 7 0% 100%

Total 8 14 36% 64%

2) Estee Lauder manufacturing/distribution/etc. locations by region

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3) Estee Lauder sales breakdown by product and region/location

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4) Estee Lauder common size Income Statement

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5) Estee Lauder Common Size Balance Sheet

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6) Calculated Ratios, including liquidity/solvency, asset management and profitability

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7) Insider Ownership and Transactions Summary

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8) Calculated Valuation Ratios

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9) Stock Price Projections

DCF-Equity model projection

*Note that both DCF Equity and Enterprise projected stock prices will be low because EL has a high beta

DCF-Enterprise model projection

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Price/Earnings Model Projection

Price/Free Cash Flow Model Projection

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Price/Sales Model Projection

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10) Stock price sensitivity tables

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11) Cosmetics industry statistics and figures

Skin and hair care make up nearly 50% of the cosmetics market, followed by makeup and perfume.

Asia Pacific and Western Europe are the largest markets for cosmetics. In the coming years, Asia and S. America are expected to experience significant growth.

Growth is also expected in the Middle East in the coming years, as well as Asia. Cosmetics companies will have to customize their products to these consumers’ demands, as well as stay afloat in competitive and volatile regions.

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12) Growth projections

Taken from finance.yahoo, in the long term, EL will grow less than the industry, and has

seen decreases in growth in this year thus far, and is projected to see more decreases in

growth through the rest of the year.

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13) SWOT Analysis

iation

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