Despite an almost 50% decline in Estée Lauder stock (NYSE: EL) since the beginning of the year, at the current price of $75 per share, we believe the company could face a significant downside. Why is that? Well, Estée Lauder’s revenues would face a significant challenge due to lower consumer spending, amid higher inflation. Now that the Fed has turned hawkish with its 2025 outlook, the consumer sentiment is expected to worsen. These factors will likely weigh on EL stock in the near term. Separately, if you want upside with a smoother ride than an individual stock, consider the High-Quality portfolio, which has outperformed the S&P, and clocked >91% returns since inception.
What’s the trigger?
Consumers have struggled in the high-inflationary environment lately. While the Fed rate cuts over the last few months suggested that inflation is under control, the recent hawkish stand of the agency seems to imply otherwise. There are a few factors at play when it comes to inflation. One is the imposition of tariffs. Higher tariffs can lead to the removal of cheaper goods from the market, ultimately resulting in increased prices for consumers. Second is deportations. Large-scale deportations could lead to higher prices for services, as many industries rely on immigrant labor to keep operational costs lower. This labor market shift would likely increase wages but also raise prices for consumers. Lastly, any reduction in taxes would result in more cash available. High consumer willingness to pay will lead to higher prices. These are some of the factors that Trump talked about during his campaign. Now, how much of this will materialize is to be seen. But a combination of these factors could imply a spike in inflation.
How does it impact EL stock?
In a high-inflationary environment, consumers tend to spend more on necessities and avoid or postpone non-essential purchases. This directly impacts Estée Lauder’s revenue. The company has seen its revenue decline 13% from $17.7 billion in 2022 to $15.5 billion now. It also saw its operating margin contract from 20% to 10% over this period. The impact on adjusted net income is even more profound, with net margin plunging to 6.1% now, versus 14.9% in 2022. Falling revenues, margins and earnings resulted in investors dumping the stock. EL stock has declined nearly 70% from $239 to $75 over this period. Interestingly, much of the decline came from a fall in earnings, while the P/E ratio declined only 14% from 33x to 29x. Probably, investors still had faith in the recovery of the stock. But what happens to investor confidence now if inflation doesn’t ease? It will likely take a hit if Estée Lauder continues to see lower margins.
The verdict?
Notably, the decrease in EL stock over the recent years has been far from consistent, with annual returns being considerably more volatile than the S&P 500. Returns for the stock were 40% in 2021, -32% in 2022, and -40% in 2023. In contrast, the Trefis High Quality Portfolio, with a collection of 30 stocks, is considerably less volatile. And it has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride, as evident in HQ Portfolio performance metrics.
Given the current uncertain macroeconomic environment around rate cuts and inflation, could EL face a similar situation as it did in 2022 and 2023 and underperform the S&P over the next 12 months — or will it see a recovery? We think there’s still more pain left for EL stock. At its current levels of $75, EL stock trades at 29x trailing adjusted earnings, versus the stock’s average P/E ratio of 34x over the last three years. However, we think a decline in valuation multiple makes sense, given the significant fall in margins and falling revenues. Furthermore, with a high inflationary environment in sight, it will be challenging for Estée Lauder to ramp up its margins. There’s the China issue as well. China has seen the demand for prestige beauty decline meaningfully in recent years, especially for foreign brands. Now, prestige beauty is a high-margin business and if that continues to adversely impact the product mix, the margin profile will continue to be weighed down. If investors adopt a more conservative stance and value Estée Lauder at 20 times earnings, the stock could potentially decline by approximately 30% from its current level.
While EL stock looks like it may face near-term headwinds, it is helpful to see how Estée Lauder’s Peers fare on metrics that matter. You will find other valuable comparisons for companies across industries at Peer Comparisons.
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