When it comes to the beauty and cosmetics industry, names such as Estée Lauder or L’Oréal probably come to mind. But like most industries, eventually a new player comes along and begins to make headway against the old stalwarts. A lesser-known cosmetics brand called e.l.f. Beauty (ELF -4.38%) is increasingly becoming a big problem for traditional leaders in the space. Fresh off an acquisition in the skincare sector, the company just reported rock-solid results for its second quarter of its fiscal 2024 (ended Sept. 30).
What’s even better is that the growth stock has taken a major breather — trading over 25% below intra-year highs. Despite a cloudy macroeconomy, e.l.f. Beauty has defied expectations and continues to figure out creative ways to market its products. I think the beauty newcomer has a greenfield opportunity to continue disrupting the makeup and skincare industry and become an undisputed leader.
Let’s break down the latest earnings report and determine if now is an opportunity to buy the dip.
Taking care of business
On the surface, it may seem like e.l.f. Beauty’s growth prospects are muted, given the number of challenges the economy faces. While the Federal Reserve has worked tirelessly to get inflation under control, the September figure of 3.7% remains much higher than the long-term goal of 2%. Moreover, interest rates have been elevated to levels not seen for nearly two decades. Given this dynamic, consumers and businesses have reined in discretionary expenses in an effort to stretch each and every dollar.
For these reasons, it would make sense for investors to question how a cosmetics company could possibly thrive in this market. So let’s take a look at e.l.f. Beauty’s most recent results and assess how the operation is performing. For the latest quarter, e.l.f. Beauty reported $216 million in revenue, up 76% year over year. What’s even more incredible is that this marked the company’s 19th consecutive quarter of sales growth and third consecutive quarter of growth in excess of 70%. That is amazing.
While top-line growth is always an encouraging sign, I’d like to move down the income statement and focus on a couple of other important metrics. For the September quarter and year-to-date basis through the first six months of fiscal 2024, e.l.f. Beauty has expanded its gross margin by roughly 5 percentage points. Accelerating revenue and expanding margins have far outpaced the company’s spending, thereby helping e.l.f. nearly triple its net income through Sept. 30.
It’s almost unheard of for a company to experience this level of consistent growth — especially one that does not operate in technology or software. With such robust top- and bottom-line performances, some investors may wonder when the music is going to stop. Well, from my stance, the music is about to get much louder. Let’s get into why.
The power of social media
The big differentiator between e.l.f. Beauty and its legacy competition is the company’s successful track record of using social media — for example, partnering with such brands as Chipotle Mexican Grill and Dunkin’ Donuts. These revolve around limited-edition makeup palettes that feature unique colors and blushes that fans of the franchises can wear and connect with the brands on a level beyond just consuming the food products each offers.
While products like these may sound a little far-fetched or even goofy, consider that the Chipotle and Dunkin’ ad campaigns generated a combined 9 billion impressions across social media channels.
E.l.f. Beauty is also dominating social media by partnering with influencers. Platforms such as Instagram and TikTok have a plethora of beauty influencers who test and review various products made by different cosmetics brands. This approach helped fuel 75% digital consumption growth during the September quarter. And what’s even better is where a lot of this growth stems from –the highly coveted Gen Z demographic.
Gen Z is known to be incredibly active on social media and prefers to use e-commerce over shopping in traditional brick-and-mortar settings. While the prospects of monetizing Gen Z more deeply can seem lucrative, investors may wonder what else e.l.f. Beauty is doing to differentiate itself. After all, consumer trends can change at the flick of a switch. It’s paramount that the company continue to innovate and offer creative products that appeal to its core audience and also drive net new shoppers to its platform.
Earlier this year, e.l.f. Beauty announced that it was acquiring Naturium to bolster its position in the skincare market. Like e.l.f., Naturium heavily utilizes social media and partners with so-called “skin-fluencers.” Now that the acquisition is closed, e.l.f. Beauty raised its total revenue guidance for fiscal 2024 by nearly $100 million and its profitability target by about $20 million.
The addition of Naturium into its portfolio should help unlock some cross-selling opportunities on social media and help further e.l.f. Beauty’s brand recognition. Both of these factors could lead to more catalysts down the road, especially as it pertains to international growth — a largely discounted opportunity at the moment.
Should you invest in e.l.f. Beauty?
The chart above illustrates e.l.f. Beauty’s forward price-to-earnings (P/E) multiple benchmarked against Estée Lauder and Coty. The basic takeaway is that e.l.f. Beauty’s valuation hovers right in the middle of these two cosmetics cohorts based on forward P/E. However, to me, this is pretty startling.
A couple of years ago, Coty struck a deal with Kylie Jenner as it looked for some much-needed inspiration. Jenner is one of the most followed people on the Internet, as are her Kardashian sisters. While this deal initially looked like a savvy move for Coty, several media outlets, including Bloomberg, are reporting that the social media mogul may be parting ways with Coty. Given how popular the Kardashians are with millennials and Gen Z in particular, I think this could potentially be a disaster for Coty’s growth prospects.
Moreover, Estée Lauder just reported earnings for its fiscal first quarter of 2024. The company’s revenue declined 10% year over year, and it lowered full-year guidance. Management attributed slowing growth in China, which isn’t entirely surprising, given that it’s not the only legacy cosmetics company to struggle in the region. What is perhaps most interesting is that Estée Lauder’s poorest-performing segment was skincare — precisely the market e.l.f. Beauty has its eyes on and the rationale behind the Naturium deal.
Yet, despite its struggling business, Estée Lauder trades at a meaningful premium to e.l.f. Beauty on a forward P/E basis. My hunch is that e.l.f. Beauty stock is massively overlooked. The company simply does not carry the same brand awareness as legacy players just yet. Moreover, given that the company sells consumer discretionary products, some investors may be seeking more steady growth in other industries.
To me, the economy will normalize at some point, thereby making e.l.f. Beauty’s prospects more compelling. However, this is somewhat of a moot point, given how successful it’s already been for several quarters in a tough macro environment. With shares trading so far below prior highs and such an upbeat outlook compared to the competition, e.l.f. Beauty stock looks like an absolute bargain right now for long-term investors.