Here’s Why You Shouldn’t Chase The Rally In Estee Lauder Stock

EL stock - Here’s Why You Shouldn’t Chase The Rally In Estee Lauder Stock

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Shares of global cosmetics giant Estee Lauder (NYSE:EL) soared after the company reported a double-beat-and-raise second-quarter earnings report which broadly affirmed the strength of the company’s underlying growth narrative. EL stock jumped more than 10% higher in response.

The report itself was very good. Revenue topped expectations, and revenue growth remained broadly robust, even in the slowing Asia-Pacific region. Earnings topped expectations, too, and margins continued on their multi-year march higher. Management lifted its sales and profit growth outlooks for 2019, as well.

Overall, Estee Lauder reported Q2 numbers and gave a great guide. That combination warrants a pop in EL stock; but that doesn’t mean investors should chase the shares here.

Instead, I think this rally might actually be worth fading. EL stock is pushing up against technical levels which have historically proven to be a top in the stock. Also, the underlying fundamentals don’t necessarily support prices above $150 just yet for Estee Lauder stock.

In short: Estee Lauder reported really good numbers which warranted a pop in the stock. But, up more than 10% on the day, this rally is overdone, and EL stock is both overbought and overvalued here.

Strong Numbers Affirm Secular Growth Narrative

Estee Lauder’s Q2 numbers were very good. Broadly speaking, they eased concerns regarding the potential for a growth slowdown amid deteriorating global economic conditions, while confirming that the drivers underlying the cosmetics markets around the world remain robust.

Revenue growth in the quarter was 11%, consistent with the past several quarters. Of note, the Asia-Pacific region saw sales rise 20% in a period that was supposed to be weak for the region. Meanwhile, essentially all product segments outside of fragrance benefited from 5%-plus constant currency revenue growth in the quarter.

In the big picture, Estee Lauder has been a healthy, 5%-plus revenue growth company for several years now. There have been healthy trends underlying the global cosmetics market, including the widespread emergence and adoption of photo-sharing and visual-first apps like Instagram and Snapchat, which have created the Selfie Generation. That population is more concerned with how they look than prior generations, and as such, are dedicating more share of wallet to cosmetics products.

This trend has powered steady 4-5% growth across the whole cosmetics industry over the past several years. Estee Lauder has grown share in this market along with sales. Nothing about either of these trends shows signs of reversing course any time soon. As such, the second quarter affirmed that Estee Lauder will remain a 5%-plus revenue growth company for the foreseeable future.

Meanwhile, on the margin side of things, Estee Lauder continues to benefit from opex leverage. Robust sales growth has allowed the company to exercise opex discipline, and drive the company’s overall expense rate lower. Consequently, as revenues have grown at a healthy rate over the past several years, margins have risen, too. This remained true in the second quarter. Operating margins rose 120 basis points year-over-year to 22.1%.

Overall, Estee Lauder’s Q2 numbers confirmed that macroeconomic weakness is having a negligible effect on the EL growth narrative, and that this remains a 5%-plus revenue growth and healthy margin expansion company.

Yet, EL Stock Looks Overbought and Overvalued

Although the numbers were good, EL stock has overshot itself here above $150.

From a technical perspective, Estee Lauder stock has already tested prices above $150 three times in the past year. The stock always quickly retreated. In April 2018, the shares hit $150, then dropped to $130 within a month. EL stock retook the $150 level in June 2018, before dropping back to $130 by August. The stock hit $150 again in early December. It dropped to $120 three weeks later.

So, history says this is a precarious position for EL stock.

The fundamentals corroborate this. At best, Estee Lauder grows revenues by 6-8% over the next several years, and operating margins trend towards 20% by fiscal 2024. Modeling those out, I think a reasonable EPS target for this company by fiscal 2024 is $8. Based on a historically average 26x forward multiple, that equates to a fiscal 2023 price target of $208. Discounted back by 9% per year (1% less than my normal 10% discount rate to account for the yield), that equates to a fiscal 2019 price target below $150.

EL stock is above that level, and we are only half way through fiscal 2019. Consequently, this stock seems reasonably overvalued here.

Estee Lauder is a great company with strong fundamentals. But, those fundamentals don’t support a $150-plus price tag for EL stock just yet. This rally will likely fade, much like similar rallies above $150 have over the past year.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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