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Morningstar | Estee Lauder Posts Excellent 3Q Results as Momentum in Asia-Pacific Persists

Wide-moat Estee Lauder's continued momentum in Asia-Pacific, which contributes about a fourth of sales, was the highlight of third-quarter results, with a 25% increase in sales in this segment (on top of 38% growth in the prior-year period) driving consolidated revenue growth of 11%. Moreover, this top-line strength enhanced operating leverage, with operating margin in the Asia-Pacific segment expanding 210 basis points to more than 25%. The Europe, Middle East, and Africa segment (43% of sales) also remained strong, with sales growing 15% and operating margin expanding 320 basis points to more than 30%. This helped offset a softer cosmetics environment in the United States (sales in the Americas region fell 2%), which remains plagued by secular declines in brick-and-mortar store traffic. Still, we expect the firm's efforts to diversify its distribution channels (with the proportion of sales it derives from North American department stores standing at just 15% in fiscal 2018 versus 24% in 2014) will help U.S. sales recover after this year. Despite this lackluster domestic performance, year-to-date profitability is ahead of our expectations, with consolidated operating margin expanding 150 basis points to 18.6% (on a full-year basis, we had expected 80 basis points to operating margin expansion to 17.5%).

These results prompted management to lift its outlook for the year, with adjusted earnings per share now expected to fall between $5.15 and $5.19 (versus $4.92 to $5.00 prior, and our $5.01 estimate). We expect to increase our full-year sales and margin outlook to incorporate further strength in the skincare segment, which should increase our $154 fair value estimate by a low-single-digit percentage. Still, we're holding the line on our longer-term outlook, which calls for above 6% sales growth and high-teens operating margin on average over our forecast, and would suggest investors wait for a more favorable entry point.

We expect industrywide tailwinds within Asia, including rising per capita beauty consumption and premiumization trends, to propel Estee Lauder's top-line longer term and forecast double-digit sales growth in the region over the next three years. Moreover, Estee Lauder's increased focus on local relevance and customization should enable it to better tailor its brands to resonate with Asian consumers, supporting both pricing power, which underscores our view of its competitive stance, and market share. For example, management alluded to the success of innovations in its namesake brand's skincare offerings (which in aggregate posted double-digit sales growth in most regions), like its Micro Essence with Sakura Ferment (launched in Japan), which was developed based on insights from data analytics and formulated for local consumers' skin type with Asian ingredients. We view this as evidence that the firm's strategy of working with its local leadership teams to gain a deeper understanding of more specific, regional consumer needs is beginning to bear fruit.

For additional information on Estee Lauder's strategy, please refer to our report "Estee Lauder's Solid Momentum Due to Innovation Focus."