Estee Lauder Companies Inc (NYSE:EL) Q2 2023 Earnings Call Transcript

Estee Lauder Companies Inc (NYSE:EL) Q2 2023 Earnings Call Transcript February 2, 2023

Operator: Good day, everyone, and welcome to the Estee Lauder Company’s Fiscal 2023 Second Quarter Conference Call. Today’s call is being recorded and webcast. For opening remarks and introductions, I would like to turn the call over to the Senior Vice President of Investor Relations, Ms. Rainey Mancini.

Rainey Mancini: Hello. On today’s call are Fabrizio Freda, President and Chief Executive Officer; and Tracey Travis, Executive Vice President and Chief Financial Officer. Since many of our remarks today contain forward-looking statements, let me refer you to our press release and our reports filed with the SEC, where you’ll find factors that could cause actual results to differ materially from these forward-looking statements. To facilitate the discussion of our underlying business, the commentary on our financial results and expectations is before restructuring and other charges and adjustments disclosed in our press release. Unless otherwise stated, all organic net sales growth also excludes an noncomparable impacts of acquisitions, divestitures, brand closures and the impact of foreign currency translation.

You can find reconciliations between GAAP and non-GAAP measures in our press release and on the Investors section of our website. As a reminder, references to online sales include sales we make directly to our consumers through our brand.com sites and through third-party platforms. It also includes estimated sales of our products through our retailers’ websites. And now I’ll turn the call over to Fabrizio.

Fabrizio Freda: Thank you, Rainey, and hello to everyone. It is good to be with you today. Turning to results. For the second quarter of fiscal year 2023, organic sales fell 11% and which was within our outlook despite the incremental pressure of COVID-19 resurgence in China. Many developed and emerging markets globally outperformed our expectations to offset the COVID-related impacts of significantly reduced retail traffic as well as limited staffing in beauty adviser, in domestic China and Travel Retail in Hainan in November and December. Adjusted EPS fell 45%. While its deep decline, this was meaningfully better than our outlook, driven by both disciplined expense management and moderation of the stronger U.S. dollars. Importantly, we continue to prudently invest for growth, launching thought after innovation and increasing A&P as a percentage of sales.

For fiscal year 2023, we are lowering our outlook for organic sales growth and adjusted diluted EPS primarily for 2 reasons. First, inventory levels in Hainan remains somewhat more elevated than we expected due to the disruptions in travel and in-store staffing levels in November and December. Second, the recently announced potential rollback of COVID related supportive measures in Korea Duty Free are creating a near-term transitory pressure to our business with our courier duty-free retailers. In the third quarter, it is more than offsetting the initial positive impact from the resumption of international travel by Chinese consumers as well as favorable trends in our second quarter, including outstanding performance across many developed markets in Western Europe and Asia Pacific as well as many emerging markets globally and a better-than-expected currency environment.

All told, our return to growth has shifted from the third quarter to the fourth quarter, which Tracey will discuss in greater detail. We remain focused on investing in our brands including for innovation, advertising, strategic entry into new countries and expanded consumer reach to fuel our multiple engines of growth strategy. Our growth engines in the second quarter were many among categories, regions and channels, and we anticipate the gradual return of more growth engines across the second half of fiscal year 2023. Beginning with categories. Fragrance extended its long-running double-digit organic sales growth streak in the second quarter, rising 12%. We are inspired by the growth prospects still ahead for the luxury and artisanal segment of the category.

As consumer unique distinct and long lasting sense of the highest quality. Many of today, consumers seek to build an occasion-based collection to express on sell differently across seasons, time of the day or events. Our portfolios of Jo Malone London, Tom Ford Beauty, Le Labo, KILIAN PARIS, Editions de Parfums Frederic Malle is ideally positioned for this accelerating fundamental shift. As demand increases globally, we are excited about our plans to bring these brands to new markets and channels in the coming quarters. Innovation will also continue to be a key growth pillar. For example, Tom Ford Beauty outstanding loans or in the first half will be followed by the cherry collection in the second half, building on the success of regional hero last cherry.

Makeup grew organically in the Americas as well as the domestic markets EMEA in across southeast Asia in the second quarter. Our brands are indeed realized in the promise of the category as professional and personal use education feed on point innovation, alluring marketing campaigns on new platforms and I think artist. MAC was a standout success. The brand growth engines were many, freestanding doors excelled, welcoming consumers with expert services delivering double-digit organic sales growth globally. Across channels, blockbuster innovation, hero products and holiday merchandise proved highly sort. Clinic further fueled makeup across subcategories led by list as the brand has created a hero franchise with almost lipstick in black honey.

Estee Lauder Double Wear foundation had exceptional success with Its My Shade, My Story campaign in Western Europe. Virality on TikTok drove strong new consumer acquisition and the franchise strengthened its #1 ranking foundation with prestige beauty share gains. Looking ahead, we are excited for the launch of Estee Lauder Pure Color lipstick in the second half. The brand reinvented its iconic franchise to capitalize on lipstick revival and integrate skin care benefits for lips. — designed to flatter all skin tones across mat, cream and luster finishes the line packaging peso edge to the brand original lipstick from the 1960s. In hair care, our brands extended the category organic sales growth streak to 8 consecutive quarters. for the second half, did launch last July in Mainland China will be complemented by the brand recent entry into Travel Retail in Haina.

— as we continue investing for the vibrant growth opportunity of prestige hair care with the Chinese consumers. Moreover, Avida became a certified B Corporation, joining Le Labo in our portfolio in achieving these important third-party validation as the brand deepened its decades-long commitment to social and environmental responsibility. Skin Care organic sales fell sharply in the second quarter. There were a few headwinds with the biggest challenge being COVID-19 in travel retail in Asia and with the Chinese consumer, given the category’s exposure. Amin, the top landscape for skin care, the ordinary was a striking success. Its organic sales growth accelerated from high single digit in the first quarter to strong double digits in the second quarter.

The brand’s hero product excelled as did the blockbuster innovation of multiple tail lash and brow serum, while the ordinary also realized outstanding performance in the specialty multichannel again, momentum for its exciting launch in India in the fourth quarter of last year. We are focused on returning skin care to growth globally with sequentially improving trends from the third quarter to the fourth quarter as a transitory pressure from travel retail abate. To that end, we have an incredibly rich innovation pipeline primed to launch. Here a few among them. Already out from MAC is its new hyper-real franchise as the brand leverage its expertise to create an artist approved skin care line of products which are purposely designed to perform also with makeup.

La Air revamped motorizing soft cream arrived this month with powerful new clinical results to reverse and receive visible signs of aging. Thereafter, Clinique will bring most Sud SPS to market. extend its popular hero product to meet consumer desire for hydration and some protection with a lightweight texture that has made MotorSerge100 age and Icon. With these launches, we aim to reach new consumers demographic tapped into high-growth subsegment. Let me now turn to geographies. While the U.S. and domestic China were challenged in the second quarter with sales falling single digit organically in each market, we believe both will be growth engines in the second half. For the U.S., we are optimistic for a return to growth given sequentially improving monthly trend in each of organic sales and retail sales performance throughout the second quarter.

Building on this momentum, the market is equipped with numerous growth drivers, including an exceptional innovation pipeline across brands roll out of new Clinique counters to select doors after a successful pilot of Clinique lab in and launch of exclusive products by many brands in specialty-multi. We are also progressively modernizing numerous freestanding store as they are primed to be an important contributor to growth following rationalization of the footprint. Moreover, our enhanced omnichannel capabilities are also primed to contribute to growth in the U.S. as consumers who engage with our brands online and in store drive consistently higher value from upsell and cross-sell. This was especially true during holidays in the second quarter.

For domestic China, we are confident in a vibrant recovery for our business following the relaxing of cove restriction. — as the economy is well positioned to rebound and Chinese consumers are passion for prestige beauty. We entered this phase with momentum having expanded our market share of prestige but in China during the second quarter, driven by gains on all of skin care, makeup, fragrance and hair care demonstrating that this ability of our aspirational brand portfolio and the excellent go-to-market strategies of our local team. While the third quarter is set to be more variable, because of the high level of covet cases, we now anticipate even stronger organic sales growth as of the fourth quarter as recovery evolves. We expect online to continue its strengths and anticipate a gradual return to more fulsome brick-and-mortar traffic by the end of the fiscal year.

Online organic sales rose single digit in the second quarter, fueled by many brands led by La Mer double-digit growth. We achieved excellent results for 11 as the Estee Lauder brand realized top ranks across platforms. Moreover, our retail sales growth in online channel meaningfully outpaced the industry in the quarter for strong prestige beauty share gains. Beyond the U.S. and China, we realized outstanding organic sales growth in many large developed and emerging markets around the world. Our local team has been executing with excellence to deliver broad-based sales gains. Western Europe, led by the U.K. prospered, while Japan and Australia contributed strongly in Asia Pacific. India, Brazil, Turkey and Malaysia are among the stars of our emerging markets with each posting strong double-digit organic sales growth led by India, rising nearly 50%.

We are very encouraged with the excellent performance we are delivering in emerging markets. As these emerging markets evolve in recovery from the pandemic, we foresee compelling long-term growth opportunity arising from the expanding middle class trading up into prestige beauty. We entered this important phase of recovery from a position of strength as we hold leading prestige beauty share in many of these markets. For example, in India, Mexico, South Africa, we are the #1 rent company in both prestige makeup and skincare, while we lead in prestige makeup in Malaysia, Thailand and Turkey. Let me now turn to the strategic deal we announced in November to acquire Tom 4. This transformational luxury acquisition will make Tumor an own brand of stellate companies.

enabling us to manage the brand’s intellectual property and equity. Staying true to our focus as a pure play in prestige beauty. We have also reached agreements with luxury companies, ZenyaGroup and Marcolin to license the brand fashion and eyewear businesses, respectively. We first partnered with Tom Ford over 15 years ago, and a singular vision of model luxury is beyond compare. Together, we have elevated to for beauty into the top echelon of high-growth luxury beauty impressively. TolfBeauty is expected to achieve $1 billion in net sales annually over the next couple of years, and we are promising profitable growth opportunities ahead. Before I close, I want to recognize the start of black Easter month in the U.S. and thank our employees to have created an engaging calendar of events for colleagues and consumers to celebrate and honor the black experience.

while we continue to focus on accelerating our commitment to raise our equity and the collective accomplishment of our equity goals year-round. In closing, while we are lowering our fiscal year 2023 outlook to reflect the additional transitory pressures affecting our Travel Retail business, — we are encouraged by both the strong underlying trends in many other areas of our business and improving macro trends. Inflation has stabilized in many markets globally the strength of the U.S. dollar has moderated. And the return to mobility domestically and international travel is happening earlier than expected. Moreover, in the first half of fiscal year 2023, we made exciting progress on several strategic initiatives to drive growth and resiliency in our business.

We significantly strengthened our capabilities in innovation, manufacturing and distribution have opened the China innovation labs our first plant in Asia Pacific, our new DC in China, while we also announced our brand portfolio with Tom Ford and Balmain Beauty. All told, we have great confidence that we will emerge from this volatile transitional year, even better positioned to realize the long-term growth opportunity of global prestige beauty to our employees, our future is bright because of your creativity, passion and wisdom. I extend my deepest gratitude for your significant contribution to our long-term success. And now I turn the call over to Tracey.

Tracey Travis: Thank you, Fabrizio, and hello, everyone. As Fabrizio mentioned, our business in the second quarter continued to be pressured by the external headwinds of COVID-related impacts, including the rising number of COVID cases in China, lower shipments of replenishment orders in the U.S. and the stronger U.S. dollar. Our second quarter organic net sales declined 11% and earnings per share decreased 49% to $1.54. We tighter expense management and a slightly improved currency impact contributed to our better-than-expected EPS results. From a geographic standpoint, organic net sales in the Americas declined 3%. The — we saw healthy demand for our holiday offerings as consumers gravitated to our in-store and online promotions.

However, we also experienced lower shipments of replenishment orders due to both retailer inventory tightening as we anticipated, and a later improvement in retail trends post-Christmas. In Latin America, organic net sales rose double digits, reflecting continued growth in nearly all markets, the evolution of recovery and makeup as consumers return to stores, and the strength of our fragrance portfolio. Organic net sales in our Europe, the Middle East and Africa region declined 17%, including the negative impact from foreign currency transactions and key international travel retail locations of 3%. The decline was driven by travel retail as expected, while growth from nearly every market in the rest of the region was strong. Our global travel retail sales were significantly pressured by the ongoing COVID-related impacts.

Despite stores being opened throughout the quarter, travel to Hainan remain largely curtailed, and as a result, shipments of replenishment inventory remained low. Elsewhere, we experienced strong sales growth in Travel Retail, reflecting increased international tourism as travel restrictions in many countries lifted from the prior year. The ongoing pressures in Asia travel retail more than offset the growth we experienced in the rest of the EMEA region, including both developed and emerging markets such as the United Kingdom, France, India and Turkey. We continue to see various stages of recovery across the region that coupled with the strong resumption of tourism fueled brick-and-mortar growth during the quarter. Organic net sales in our Asia Pacific region fell 7%, primarily due to the ongoing COVID-related impacts in Greater China.

This affected brick-and-mortar sales in Greater China and Dr. Jart Travel Retail in Korea. Online sales continued to grow in Mainland China due in part to the expansion of our online presence with the recent launches on JD and Joyn as well as solid performance during the 11.11 Shopping Festival. Most of the other markets in the region continued to progress in recovery as the return of brick-and-mortar traffic led to high single-digit or double-digit growth in Japan, Australia, Malaysia and the Philippines. From a category standpoint, fragrance continued to lead growth with organic net sales rising 12%. Strong holiday demand for our beautiful line of fragrances from Estee Lauder and double-digit growth from both La La bond Tom Ford Beauty propelled the category’s growth in every region during the quarter.

Organic net sales in hair care rose 4% and declined 3% in makeup, the latter driven primarily by the COVID restrictions in China as solid performance from both MAC and Clinique drove growth in both the Americas and in domestic markets in EMEA. Organic net sales in skin care declined 20%. This category continues to be the most affected by the COVID restrictions in China, particularly in Asia travel retail and Mainland China, where skin care accounts for a large majority of our business. Our gross margin declined 430 basis points compared to last year. The positive impacts from strategic pricing in this quarter were more than offset by inflationary pressures in our supply chain, region and category mix, and higher costs due to promotional items.

Operating expenses increased 500 basis points as a percent of sales, driven primarily by the reduction in sales. This also reflects our investments in areas such as advertising, promotional activities and innovation, which increased 150 basis points compared to last year. Operating income declined 46% to $768 million, and our operating margin contracted 930 basis points to 16.6% in the quarter. During the quarter, we recorded $207 million of impairment charges related to the 3 brands, primarily reflecting lower-than-expected growth in key geographic regions and channels given the pressure on consumer demand from the impacts of COVID. Diluted EPS of $1.54 decreased 49% compared to last year. The impact from foreign currency translation and foreign currency transactions in key travel retail locations negatively impacted diluted EPS and by 5% and 4%, respectively.

During the quarter, we generated $751 million in net cash flows from operating activities compared to $1.8 billion last year. The decline from last year reflects lower net income and the negative impact from changes in working capital, primarily due to the timing of payments. We invested $419 million in capital expenditures, and we returned $708 million in cash to stockholders through both dividends and share repurchases. As we expected, our first half performance was pressured by ongoing external headwinds. Let me now turn to our outlook for the remainder of fiscal 2023. For the second half of fiscal 2023, we are encouraged by the easing of COVID restrictions in China and the expected return of travelers throughout Asia and around the world once more stabilization occurs with outbound flights and visas as well as cover entry and testing requirements.

In Hainan, we are starting to see increased positive signs already. as traffic level declines have moderated in recent months. However, retailer inventory levels are still somewhat elevated, reflecting the impact of the lengthy store closures as well as the rapid reduction in traffic and in-store staffing levels in November and December. And in Korea travel retail, an incremental headwind has emerged since the last outlook we provided in November. The recently announced potential rollback of COVID-related supportive measures in Korea Duty Free is creating a near-term transitory pressure to our business with our Korean duty-free retailers, which is pressuring our third quarter outlook. We now also expect more moderate net sales growth near term in our China business as the rise of Cove cases in November and December slowed expected brick-and-mortar retail traffic and social usage occasions.

— which continued in January during the pre-Lunar New Year shopping time frame. Collectively, we expect these impacts to create greater headwinds in the third quarter than we originally anticipated. As a result, we are updating our outlook to reflect a shift in the start of the travel retail recovery in Asia from the third to the fourth quarter of fiscal 2023 due to the normalization of inventory levels in Hainan, the uncertain pace of recovery of travel retail traffic in Korea and a more moderate acceleration of growth in China. The momentum from our other developed and emerging markets in EMEA and Asia Pacific in the first half is expected to continue as those markets progressively evolve in recovery. We are also cautiously optimistic and expect our North America net sales performance to improve as our retail growth trend in the region has already increased, particularly in January.

— and we have a supportive innovation pipeline planned for the second half, as Fabrizio mentioned. As it relates to our operating income, while these external headwinds have introduced a high level of volatility and that has had a meaningful impact on our financial results this fiscal year. We remain confident in the ongoing strength of prestige beauty, our business strategy and our ability to reaccelerate long-term profitable growth. We, therefore, plan to sustain the strategic investments imperative to that growth, including innovation, advertising and continued geographic expansion for many of our brands. These investments also support the continued strengthening of our multiple engines of growth as we invest in emerging markets and faster growth channels that are already progressing well in their recovery.

As a result, we expect to see pressure on our operating income in the third quarter with an accelerated improvement in the fourth quarter as the sales recovery in travel retail, Mainland China, and skin care start to materialize more meaningfully. The negative impacts from foreign currency that we anticipated in our previous guidance have improved due to the recent weakening of the U.S. dollar. However, currency is still expected to be a meaningful drag our reported sales and diluted EPS growth for the third quarter and full year. Our outlook is now based on December 30 spot rates of 1.067 for the euro, 1.207 for the pound, 6.964 for the Chinese yuan and 12.63 for the Korean yuan. So with that backdrop, our guidance is as follows: we expect organic sales for our third quarter to decline 10% to 8%, primarily reflecting the pressures to our Travel Retail business that I mentioned previously.

Currency translation is expected to be dilutive to reported net sales by 3 points and the impact of certain foreign currency transactions in key international travel locations is not expected to be material. The impact of sales from certain designer fragrance license exits are expected to dilute reported growth by approximately 1 point. We expect third quarter adjusted EPS of $0.37 to $0.47 for a decline between 81% to 75%. Currency translation is expected to be dilutive to EPS by $0.04, such that constant currency adjusted EPS is expected to decline between 79% to 73%. This includes the negative impact from certain foreign currency transactions and key international travel retail locations of approximately 1 percentage point. For the full year, SP27916451 assuming a reacceleration of Travel Retail in the full range between down 2% to flat.

Currency translation is expected to dilute reported sales growth for the full fiscal year by 4 percentage points and we expect an additional 1 point of dilution from the impact of certain foreign currency transactions in key international travel retail locations. The impact of sales from certain designer license exits are expected to dilute reported growth by approximately 1 point. We expect full year operating margin to be approximately 15.1%, a 460 basis point contraction from the prior year period primarily due to the geographical and category mix of sales and foreign currency impacts as well as the sustained investments to support recovery as previously mentioned. We now expect our full year effective tax rate to be approximately 25.5%, reflecting in part the change in our estimated geographical mix of earnings.

Diluted EPS is expected to range between $4.87 and 502 before restructuring and other charges. This includes approximately $0.29 of dilution from currency translation. In constant currency, we expect EPS to fall between 29% and 27%, which includes a negative impact from foreign currency transactions and key international travel retail locations, of approximately 4 percentage points. Regarding the Tom Ford brand acquisition, we expect to complete this transaction in the fourth quarter and to fund it through a combination of cash, debt and deferred payments. In anticipation of closing this transaction, in January, we increased our commercial paper program by $2 billion. We also estimate a slight EPS dilution to the full year outlook that I just provided due to the final purchase accounting inclusive of transaction costs.

While this year has undoubtedly been a perfect storm of unforeseen macro pressures on our business, and the transition to accelerated recovery has indeed been longer than we anticipated, we have navigated through the challenging environment and strengthened the company in the process, thanks to our amazing employees, our company values and our multiple engines of growth strategy. We are encouraged by the many signs of improvement in the overall environment and the progress our incredible teams have made in preparing us for a strong recovery. Our fundamentals are solid and intact, reinforced by the actions we have taken over the past few years. From the acquisition of the majority interest in in fiscal 2021 to the recent announcement of our agreement to acquire the Tom Ford brand and the Balmain license agreement.

We are expanding our brand portfolio at both the entry and luxury levels of prestige beauty. We’ve taken strategic actions to enhance our go-to-market capabilities, supply chain agility and local relevance through our new innovation, production and distribution facilities in Asia. We’ve enhanced our digital marketing capabilities and continue to progress on our ESG initiatives. These actions and many more demonstrate that we remain confident in the long-term sustainable profitable growth of our business. And that concludes our prepared remarks. We’ll be happy to take your questions at this time.

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Q&A Session

Operator: Our first question today comes from Lauren Lieberman with Barclays.

Lauren Lieberman: I was hoping — and this is probably more for you, Tracey. If you could walk through with us how you’re I guess, the length of the supply chain works for supplying both Hainan and Mainland China currently, knowing it’s shifting. Because as we think through the change forecast in demand and knowing what I believe is a pretty lengthy supply chain, how you’re managing production versus shipments and if that’s sort of informing why there’s so much visibility seemingly on 4Q. And I guess we should see inventory spike up on your balance sheet in 3Q. Is that right?

Tracey Travis : Yes. You’re correct, Lauren, that we do expect that we will — two things. One, inventory levels are still coming down in Hainan. They are almost at the level that we would expect sales to accelerate. So yes, you should start to see an inventory build related to the shipments that we expect to see in Q4. In Korea, again, the pace is a little bit more uncertain given the transitory nature of what’s going on right now. So we do anticipate, as I mentioned in the prepared remarks that we will start to see resumption of travel in Korea. And depending on the pace of that resumption that will depend on the amount of shipments that we have in the quarter. But we have taken obviously an assumption there. We are sitting on a decent amount of inventory even in our own warehouses to supply the sales that we expect to see in the fourth quarter.

Operator: The next question is from Dara Mohsenian of Morgan Stanley.

Dara Mohsenian: So just sort of extend that question a little bit, right? We have a lot of quarterly volatility in terms of Q3 versus Q4. Q2, there’s a difference in shipments versus underlying retail sales. Obviously, COVID impacts in China. So it’s hard to get a great underlying sense of retail sales here and how the business is doing. So a ratio, maybe you can just give us a little bit of an update on retail sales by region I’m particularly interested in category growth and any macro impacts in the U.S. and Europe? And then how you’re thinking about Asia Pac and China versus the rest of the region. Let’s so — on near-term results here, but more how results came into the quarter versus what you originally expected and that might inform the revenue trajectory as you look out over the next couple of years and how you think about it? I think you touched on a lot of aspects of that, but it would be helpful to get a general overview.

Fabrizio Freda: Yes. No. Absolutely, with pleasure. Let me start with China, first of all. And so China, the results in the quarter where pretty good. We built significant market share. So the overall market in China was negative double digit. Our net sales were and our retail was negative single digits, and we built market share in every single category. So in most arises, we build market share in makeup in fragrance, in health care in every aspect. Now this, for us, is a very important sign that the — our brands are really working the aspirational value of our brands remains very, very strong, which in the moment of reopening is a very strong position to be. So excellent performance relatively to market. Though some of our brands were shining, La Mer in skin care was the brand that was gaining the best market share on for beauty in makeup and Jo Malone London in fragrance was really leading the share gain.