Stocks Fools Love
February 11, 1998

Estee Lauder
by Dale Wettlauffer (TMF Ralegh)

Estee Lauder <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EL)") else Response.Write("(NYSE: EL)") end if %>
767 Fifth Ave.
New York, NY 10153
(212) 572-4200
$58 3/8 as of February 9, 1998

Hmm, I thought as I sat down to write this. Should I go with Nike <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NKE)") else Response.Write("(NYSE: NKE)") end if %>, that global powerhouse brand whose return to shareholders since I fell in love with it on Valentine's Day two years ago has beaten the long-term rate of return of the S&P 500? Well, as much as I find it very attractively priced at a tidge over $41 with management expecting to generate about $2 per share in earnings in 1998 and planning a stock buyback of $1 billion over the next four years, I imagine you are probably already familiar with this story.

No, I'm going to tell you about a new love. Estee Lauder came to my attention early last year and since then I haven't been able to get her off my mind. Well, not her, but the company that bears her name. You want global brands, sheer cash generating power, market share, and growth, you say? Well, then, Fool, put on your G suit, because I have a story that could give your portfolio a makeover.

Brand names in the Estee Lauder stable include its namesake skin care products, including Estee Lauder Fruition extra and its new Diminish Retinol Treatment and cosmetics, and:

- Clinique: A full line of unique, fragrance-free skin care products, cosmetics, and perfumes such as "happy" and "wrappings."

- M.A.C.: An acquired brand started by professional make-up artists (hence the acronym from Make-Up Artists Company). This is an upscale brand that has captured market share with fashion-conscious younger women. The pricing power on this brand is astounding. Women will pay more than three times as much for its cosmetics than drug store brands. While there are qualitative elements to the products' superiority, pricing power is the hallmark of a brand name with staying power.

- Bobbi Brown: Another upscale line of cosmetics. In fact, Estee Lauder owns 45% of the "prestige" market for cosmetics, meaning it sells nearly half of department store cosmetics. Estee Lauder's international reach is helping to grow this brand, which is another favorite of younger women (no idea what brands makeup-wearing guys like).

- Aveda: The company's newest acquisition, Aveda has a fanatical following of customers. Aveda's hair care products, cosmetics, skin care stuff, and fragrances (Pure-fumes) are all-natural, as is most of the product line: "That's why we use plant derived ingredients, organically grown whenever possible. With the active energy of plants -- with the natural ability to soothe, invigorate and refresh."

- jane: Another new acquisition. Sassaby's jane line of cosmetics is Estee's entry into the mass drug store market. This line is popular with young women and should benefit from not only the company's advertising resources, but also from its global reach.

Other Estee Lauder names include Prescriptives, Origins, Aramis for men, tommy and tommy girl, and Kiton fragrances in Europe.

About 30% of Estee Lauder's sales have come from products that have been introduced in the last couple years and the company has a healthy acquisition appetite. The reason why Estee Lauder's 75% gross margin ends up as a net profit margin of around 7% is its intensive advertising and marketing budget. Global brand leaders don't just spring up magically -- there is a care and feeding of brands that needs to be performed. Down the line, brand awareness and mindshare will allow the company to send more dollars to the bottom line. In the last quarter, some of that was seen, as operating income increased 15% on revenue growth of 6.3%. In the meantime, the 30% return on invested capital the company generates is excellent for a growing company.

At 22.5 times earnings and 18 times cash flow (earnings plus depreciation and amortization), Estee Lauder isn't cheap -- but neither are the other excellent brand-oriented companies. However, its capital investment needs aren't great, which increases owners' earnings (free cash flow). In addition, the company's pricing power and ability to generate a return on capital far in excess of the cost of capital allows for flexibility in increasing shareholder wealth. Since coming public in 1995, the company has already generated a 31% annual return to shareholders. For a growing global brand with excellent market share and good prospects for expanding margins (royalty payments on European sales, for instance, will cease upon the death of company founder Estee Lauder), Estee Lauder is quite attractive.

For more company background, check out the Databexcorp database at http://www.databexcorp.com/.

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