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Key Market Outlook(s) and Pick(s)

On Tuesday, I joined Stuart Varney on Fox Business’s “Varney & Co.” for the full hour to discuss markets, outlook, the Fed, PayPal, Boeing, Advance Auto Parts, and Estee Lauder. Thanks to Stuart, Christian Dagger, and Peyton Jennings for having me on:

On Wednesday, I joined Brian Brenberg, Jackie DeAngelis, Cheryl Casone, and Charles Gasparino on Fox Business’s “The Big Money Show” for the full hour to discuss markets, outlook, stock picks, and more. Thanks to Brian, Jackie, Cheryl, Charles, and Madison Murtagh for having me on:

On Monday, I joined Josh Lipton on Yahoo! Finance’s “Market Domination” for both the full one-hour show and a separate half-hour segment to discuss markets, outlook, stock picks, and more. Thanks to Josh and Taylor (Smith) Clothier for having me on:

Watch Part 1

Watch Part 2 

On Wednesday, I joined Kristen Scholer on NYSE TV to discuss markets, outlook, stock picks, and more. Thanks to Kristen and Mel Montanez for having me on:
 

Estee Lauder Update

Each week we try to cover 1-2 companies we have discussed in previous podcast|videocast(s) and/or own for clients (including personally).

Last month, we put out a quick update following Estée Lauder’s Q3 earnings but had not yet published a full deep dive. After falling below $50 a share at the April lows, the stock has been on a tear, rallying more than 50% off the bottom. Just this week, Deutsche Bank turned bullish on the turnaround story and issued a street high price target of $95. We thought now would be a good time to revisit the name.

Estée Lauder, founded in 1946, is the global leader in premium beauty products with a portfolio of over 20 best-in-class iconic brands. EL is basically to makeup and beauty what Diageo is to alcohol. Both are about as premium as it gets.

The stock was never a huge position for us. Like Alibaba, it is largely a bet on the recovery of the Chinese middle class. And just like in poker, we prefer positions with plenty of outs, and few offer more outs than BABA. So while EL may not be the “everything” business that Alibaba is, it still offers what we believe is a HIGHLY ATTRACTIVE risk reward setup.

Estée Lauder’s roller coaster story over the past few years goes like this. When prior CEO Fabrizio Freda took the helm in 2009, his top priority was international expansion, aiming to generate over 60% of overall sales from international markets. That bet proved highly successful over the next decade but also opened the door to significant overexposure to certain markets, especially China and Travel Retail.

From FY2018 to FY2021, China’s share of total revenue jumped from just 13% to 36%. At one point, a single customer in China was responsible for 42% of the region’s sales. Management clearly bit off more than they could chew, and when the music stopped in 2022, EL paid the price. Shares fell from nearly $375 to below $50 this past April, effectively wiping out more than a decade of gains.

Now this is exactly the kind of situation that earned me the nickname “Turnaround Tom.” As Buffett says, “Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised.” This could not be a more accurate description of EL. At the end of the day, this is a company that is as high quality and durable as they come, working its way out of a once-in-a-hundred-year event, yet priced as if it is in permanent decline and people will never spend money on makeup again.

We are more than happy to take the other side of that trade. That’s because we see the bulk of EL’s challenges as CYCLICAL, not structural, with all signs pointing to a bottoming and near-term recovery.

The name of the game with the EL turnaround is margin expansion. Gross margins fell nearly 500 basis points peak to trough, bottoming in FY2024 at 71.7% as management worked through excess inventories and write-offs. The good news is that gross margins have now posted three consecutive quarters of 300+ basis point gains, with current guidance calling for 73.5% for FY2025 and an expected return to the historical mid 70s range by FY2027.

Operating margins are where the crux of the turnaround really is. EL has historically delivered mid to high teen EBIT margins, but in 2024 these bottomed out at just over 10%. Management is working to restore EBIT margins to a solid double-digit level over the next few years, with the Profit Recovery Growth Plan expected to generate $800 million to $1 billion in annual gross savings and full run rate benefits anticipated by FY2027.

Green shoots across the business continue to point toward a return to growth in 2026, which will allow operating leverage to really kick in and get EL back to making more money than they know what to do with. At the same time, you have a new CEO who is a proven winner in the industry, a push into higher margin digital channels like Amazon and TikTok, and China working its way toward becoming a “mega-sized” consumption economy.

We think over the next few years, this is a double from current levels. Until then, we are happy to sit on our hands and wait.

Now here’s an in-depth breakdown of Estée Lauder’s Q3 earnings:

10 Key Points

1) After sales declined 10% in FY2023 and 2% in FY2024, and with guidance calling for another 8 to 9% drop in FY2025, management remains confident in a return to growth by FY2026.

2) Gross margins bottomed in FY2024 at 71.7%, below the five-year average of approximately 74%, but have rebounded for three consecutive quarters with gains of over 300 basis points. FY2025 guidance calls for 73.5%, and management continues to target a return to the historical mid-70s range by FY2027.

3) Management also remains confident in restoring operating margins to solid double digits over the next few years, as a return to sales growth allows operating leverage to kick in. Margins bottomed in FY2024 at just over 10%, well below the company’s historical mid-to-high teens EBIT levels.

4) Green shoots are emerging across the business, with market share gains showing up in the U.S., China, and Japan. In the U.S., Q3 marked the first quarter in years with share gains, driven by growth in three of four categories (skin care, makeup, and hair) and 10 brands that held or gained share, led by Clinique, which has now posted 11 consecutive quarters of gains. In China, EL  gained share across all four categories and eight brands, making it the third quarter of share gains in the last four. In Japan, Q3 marked the fourth straight quarter of market share growth.

5) Tariffs are not expected to have a material impact on FY2025 profitability. EL has the lowest exposure in the industry thanks to its nine manufacturing sites worldwide. Over 75% of what is sold in the U.S. is sourced from the U.S. or Canada and is protected under the USMCA agreement. ~25% of what is sold in China is currently sourced from the U.S., but management aims to reduce this to less than 10% and has already mitigated north of 40% of the initial tariff impacts.

6) Travel Retail, which at its peak accounted for mid- to high-20% of total sales, continues to shrink to the low teens as a share of sales. Management is intentionally diversifying away from volatile Travel Retail, significantly reducing inventories and de-risking the segment. Outside of Travel Retail, which declined 28% in Q3 and is expected to see another steep drop in Q4, EL delivered sequential acceleration in global retail sales growth.

7) Management remains on track with the expanded Profit Recovery Growth Plan (PRGP), which is expected to generate $800 million to $1 billion in annual gross savings, with full run-rate benefits anticipated by FY2027. As of Q3, management has approved initiatives to eliminate over 2,600 net positions, with 85% expected to be completed by the end of FY2025, and has already reduced middle management roles by 20% year over year.

8) EL continues to lean into higher growth, higher margin digital channels, with online organic sales up mid single digits in Q3. This includes 12 brands now available through Amazon Premium Beauty stores as well as momentum on TikTok Shop, helping digital channels reach 28% of total sales in 2024, up from just 13% in 2018. At the same time, exposure to department stores has been significantly reduced as a share of overall sales.

9) Capital expenditures totaled $395 million (3.62% of sales) in the nine months ended Q3, down 44% from $702 million in the prior-year period. Construction of the new factory in Japan had pushed capex as a percentage of sales to around 6% in recent years, above the historical average of 4 to 5%, but spending is now expected to remain lower as management shifts focus toward higher ROI projects and reallocates capex toward consumer-facing initiatives rather than capacity and capabilities.

10) In the first few weeks of Q4, management has continued to see strong retail momentum in the U.S., even stronger trends in China, and positive momentum in the UK and across other emerging markets.

Earnings Call Highlights

Morningstar Analyst Note

General Market

The CNN “Fear and Greed Index” ticked down from 61 last week to 56 this week.  You can learn how this indicator is calculated and how it works here: (Video Explanation)

The NAAIM (National Association of Active Investment Managers Index) (Video Explanation) ticked up to 94.09% this week from 82.66% equity exposure last week.

Congratulations to all of the new clients that came in during our Q1 and Q2 2025 raises.  You could not be better positioned for what we believe will continue to be a highly rewarding remainder year in 2025.  This view is based on what has already taken place in 2025 as well as much of the data we have shared in recent weeks on our podcast|videocast(s), coupled with our proprietary methods of expressing and executing upon those views on your behalf.

We will re-open to smaller accounts $1M+ again starting July 1st.

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