Beauty Stocks: 3 to Buy, 3 to Leave

by Susan J. Aluise | May 11, 2012 10:01 am

“Beauty is a short-lived tyranny,” Socrates said, a view shared by any investor who has been burned betting on the wrong beauty-industry stocks. This month has been wild for beauty shares — and not just because of Mother’s Day.

You’re thinking, “The Mother’s Day reference makes sense, but why Socrates?”

Given the buzz in recent years about Socratic investment principles[1], it makes sense to consider the Father of Philosophy’s wisdom when evaluating the stocks of beauty pure plays and conglomerates with large cosmetics/personal-care businesses.

One principle that’s as valid today as it was in Socrates’ time: “Question everything.”

With that in mind, here are three beauty stocks to buy and three to leave on the shelf:

BUY: Elizabeth Arden

Elizabeth Arden (NASDAQ:RDEN[2]) is a global company that sells upscale skin care, fragrances and luxury cosmetics. Key brands include its namesake skin-care line and celebrity fragrances such as Elizabeth Taylor. The company has been in the midst of repositioning the Elizabeth Arden brand since mid-2010.

RDEN last week reported a $2.2 million profit for its fiscal third quarter, a reversal from last year’s $3.3 million loss. Earnings beat Wall Street estimates, but revenue — which rose 3.5% — missed.

Although U.S. sales grew by only 2%, international sales jumped 6%

With a market cap of a little more than $1 billion, RDEN is trading around $37, more than 41% above its 52-week low last August. That makes it one of the lowest-priced beauty stocks in the category right now. It has a forward P-E of a little over 15 and a price-to-earnings growth (PEG) ratio of 1.6.

Unconventional Wisdom: RDEN has experienced strong demand from international customers, particularly in Asia. I also think it’s a solid beauty stock. The repositioning aims to convey the company’s luxury-spa image to global markets. If RDEN can boost the brand’s global ranking from 15 to 10 or better, it believes it will double its business, to more than $1 billion in retail sales. I’m optimistic about the strategy: My price target is $45.

BUY: ULTA Salon, Cosmetics & Fragrance

ULTA Salon, Cosmetics & Fragrance (NASDAQ:ULTA[3]) is a chain of beauty superstores that features more than 20,000 prestige and mass-market beauty products across all price points, including makeup, fragrance, skin care, bath and body, hair-care tools and salon services.

The company last week said preliminary same-store sales, revenue and profit for the quarter ended April 28 are significantly higher than management had estimated. ULTA, which opened 18 new stores in the quarter, will report earnings on June 5. Shares rose 2% on triple the normal volume on Thursday.

With a market cap of $5.4 billion, ULTA currently is trading around $86 — 79% above its 52-week low in September. The stock has a forward P-E of over 27, which is pretty high even in an industry with high multiples. Its PEG ratio looks better at 1.3, with a PEG of 1 indicating that a stock is fairly valued.

Unconventional Wisdom: Even though ULTA shares have gone through the roof lately, I think there’s still altitude left. The beauty superstore is delivering to a great niche. My price target is $100.

BUY: Estee Lauder

Estee Lauder (NYSE:EL[4]), which manufactures and markets cosmetics, skin care, hair products and fragrances, includes high-end brands such as Smashbox, Clinique, Aveda and La Mer. The company’s earnings rose 5% in the most recent quarter, as affluent consumers in the U.S. have given the lines a rebound.

In its third-quarter report earlier this month, EL said higher demand from international customers for its lotions, perfume and makeup delivered a profit of $130.4 million, up from $124.7 million a year ago.

With a market cap of nearly $23 billion, EL is trading around $59 — 45% above its 52-week low last October. It also has a high forward P-E of 26 and a PEG ratio of 1.7.

Unconventional Wisdom: Explosive growth in China also has driven sales; the Estee Lauder and Clinique skin-care lines alone grew by 14% globally. But when the company warned last week that the slowdown in China could have an impact on sales, the stock took a hit: It has fallen by nearly 9% since May 4. Nevertheless, I think it’s a quality stock with upside. In fact, China fears may help investors buy in on a dip. My target price is $67.

LEAVE: Avon Products

Avon Products (NYSE:AVP[5]). The last few months have been a whirlwind at the 125-year-old cosmetics company — and not in a good way. Sales have slumped and quarterly earnings missed Wall Street estimates by over 60%. Avon also changed CEOs, replacing Andrea Jung with Sherilyn McCoy, who had lost the race to succeed departing Johnson & Johnson (NYSE:JNJ[6]) CEO William Weldon to Alex Gorsky.

Privately held rival Coty’s first unwelcome bid of $10 billion was rebuffed by Avon, but the fragrance company came back this week with a sweeter deal — with Warren Buffett helping to fund it[7].

AVP has a market cap of $9 billion and is trading around $21, nearly 32% below its 52-week high last August. The stock fell almost 4% on Thursday on volume of 43 million shares — more than five times the normal daily volume. The stock has a forward P-E of 21 and a PEG ratio of 3.8, among the highest in the sector.

Unconventional Wisdom: The price is right, but Avon’s business model and management are wrong. I’m far more likely to believe in Coty’s Buffett-enabled bid than in McCoy’s ability to make enough changes fast enough to help Avon rise again. Even a current dividend of 4.7% can’t make AVP look pretty.

LEAVE: Procter & Gamble

With Olay skin care recently named the most valuable beauty brand in the world[8], parent Procter & Gamble (NYSE:PG[9]) would seem to be a great bet for beauty investors.

But there are some deep wrinkles in P&G’s business model. Gina Drosos, the 49-year-old head of P&G’s global cosmetics, skin and personal-care business, will retire in September when the company relocates that division to Singapore[10]. Company veteran Deb Henretta, group president of P&G’s Asia and global-specialty channel, takes over the unit, which will improve its fortunes, though not quickly.

With a market cap of $176 billion, P&G is a lot more than its beauty and skin-care division. The stock is trading around $64, about 11% above its 52-week low last August. It has a forward P-E of about 17 and a PEG ratio of nearly 2.

Unconventional Wisdom: P&G is a huge conglomerate, so one business unit’s performance seldom makes or breaks its fortunes. Still, the company’s skin and personal-care unit has been a notable disappointment lately. You read my comprehensive breakdown of P&G’s challenges here[11]. But until the company finds a way to raise margins against its competitors, I’d leave this stock in the package.

LEAVE: Revlon

Revlon (NYSE:REV[12]) appears cheap compared with other beauty stocks, but looks can be deceiving. Revlon is a broad-based manufacturer and marketer of beauty products. Product categories include cosmetics, skin care, hair color, fragrances, deodorants and beauty tools. Brands include Revlon and Almay.

First-quarter earnings fell by 18%, and revenue slipped by 1%. But color cosmetics and Revlon ColorSilk hair color had strong sales. The biggest challenges: narrowing margins and significant debt.

With a market cap of $785 million, REV is trading at only $15, which is 34% above its 52-week low last October. The stock has a forward P-E of only 9 and a PEG of just 0.8, so Revlon looks very undervalued compared with its peers in this sector.

Unconventional Wisdom: Revlon is building back from the fire that destroyed much of its facility in Venezuela last year. Margins have remained steady, and product launches such as Revlon’s ColorBurst Lip Butter and ColorStay Nail Enamel are performing well.

But I don’t think REV will deliver ULTA or RDEN growth rates anytime soon. If the economy slows, Revlon’s lower product prices could benefit from the Lipstick Index[13], but I’m not convinced of any near-term upside, and the potential risks are higher than the rewards now.

As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.

  1. Socratic investment principles:
  2. RDEN:
  3. ULTA:
  4. EL:
  5. AVP:
  6. JNJ:
  7. with Warren Buffett helping to fund it:
  8. the most valuable beauty brand in the world:
  9. PG:
  10. the company relocates that division to Singapore:
  11. here:
  12. REV:
  13. Lipstick Index:

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