The Avon-Estee Lauder Beauty Contest

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TV reality shows such as The Swan or Extreme Makeover feature average people willing to embrace extreme measures, including surgery, to improve their appearance. It's the latest proof that the ageless cult of youth and beauty has lost none of its magnetic appeal. And if those shows aren't enough to make the point, just look at personal-products companies Avon Products (AVP), known for its direct-sales strategy, and Estee Lauder (EL), parent of the namesake department-store beauty line and other high-end brands. Despite consumer products' modest growth in general, financial performance at both Avon and Estee Lauder look mighty appealing.
In the first quarter ended Mar. 31, Avon's earnings were up 48%, to $148.1 million, on sales of $1.75 billion, a 19% increase. At Estee Lauder, earnings in the fiscal third quarter, which ended Mar. 31, jumped 26%, to $98.3 million, on a 15% gain in sales, to $1.42 billion. Both stocks have reflected those robust numbers. Avon is up more than 40% over the past two years, near an all-time high of $85, while Estee Lauder has risen 25%, to $46.
ARMY OF REPS. The earnings glow should linger at both companies, with the weak dollar continuing to boost revenue gains from overseas sales. And Estee Lauder brands like Stila and Clinique have fared well over the past year, as affluent spenders came back in full force. Avon, which sells lower-price products via its famous Avon Ladies, is expanding abroad. In the past year, this worldwide army of sales reps grew by 9%, to 4.4 million doorbell-ringers, and Avon is implementing a cost-cutting plan that should see several more years of improving margins.
Given how much they've risen, these stocks may not have much upside potential in the short term. But for investors attracted to the beauty sector, Avon likely has a slight edge over Estee Lauder, analysts say. The latter's forward price-earnings ratio is 25.8 times fiscal 2005 consensus earnings, while Avon trades at 23 times 2005 consensus expectations.
"I like both, but I think Avon is a better long-term growth story," says Tatiana Pohotsky, consumer analyst at Independence Investments, a subsidiary of Manulife. What she finds particularly appealing is that Avon continues to cut costs even as sales rise. As she notes, that makes it one of the few consumer-products companies to have both factors working in its favor. (Pohotsky owns stock in neither company, but her firm has holdings in both Estee Lauder and Avon.)
TRIMMING DOWN. Most of Avon's growth in coming years is expected to be rooted in the developing world. In Russia, Central Europe, Brazil, and other economically expanding nations, the direct-sales model has more draw than it does in the U.S., where it started. "At Avon, they're not just selling the product, they're selling women the opportunity to make a living," notes Pohotsky. "That's very powerful." Carl Sibilski, an analyst at independent investment research firm Morningstar, figures Avon should be able to expand its global sales force by 5% to 10% annually. (Sibilski doesn't own the stocks.)
Also, Avon's cost-cutting initiative is just beginning to be reflected in the numbers. The business is integrating its supply chain, streamlining its packaging, and trying to wean customers from its well-known discounting. A good sign the efforts will take: Avon's Supply Chain Vice-President Lou Mignone was the brains behind Colgate's (CL) impressive cost-cutting efforts in the 1990s.
"I look at Avon's savings coming through 2006," Pohotsky says. The outfit recently increased full-year earnings guidance to $3.30 per share, up from a range of $3.18 to $3.20. That means Avon sees earnings per share jumping about 18% from 2003's $2.78.
REJUVENATED. The savings and efficiency measures first launched in 1999 will make the biggest impact in 2005, predicts Avon spokesman Victor Beaudot. Avon aims to post $8.5 billion in annual sales in the 2005-07 time frame at a 20% operating margin, up from $6.9 billion in sales and a 15.2% operating margin in 2003.
By comparison, Estee Lauder had a "big growth push" in the late 1990s, says Pohotsky, when it added niche cosmetic and skin-care names -- like M.A.C. -- that are still doing well today. In 1995, earnings grew 30% and continued to sustain an impressive pace for several years. But Estee Lauder has also taken its share of recent lumps. Sales suffered after the September 11 terrorist attacks, as did earnings.
The business has since rebounded. And with the economy on the mend and ongoing gains from its own cost-cutting efforts, Estee Lauder's earnings are expected to grow 24% in fiscal 2004, which ends June 30, Pohotsky says. Projected earnings for fiscal 2004 are in the range of $1.59 to $1.62, on a 13% sales increase.
COUNTER CULTURE. Following the recent death of Estee Lauder's founder and namesake, analysts expect her grandson and company Chief Operating Officer William Lauder to take over the CEO position at the end of June. In the nearly 20 years since he joined the family business, Lauder has served in numerous positions in many divisions.
Maintaining the appeal of older brands, like its flagship Estee Lauder line, to younger women has been a challenge, but the cosmetics maker continues to find growth elsewhere. Sibilski was skeptical when Estee Lauder announced that it would open stores for lines like M.A.C., Origins, and Aveda. But the concept has done well, he says, and Estee Lauder plans to expand to a total of 500 stores across several brands within the next several years.
It recently nixed its Jane cosmetics line, which unsuccessfully targeted a younger set. However, in the fall Estee Lauder will launch a beauty brand for Kohl's KSS) -- a venture that analysts believe has definite potential.
WAIT FOR A DIP. After the run each stock has enjoyed, neither is cheap. "They're both riding high right now," notes Sibilski, who adds: "We're not positive enough to put money in at these levels." Still, if Avon were to disappoint even slightly on earnings, history suggests that the Street's initial reaction could represent a buying opportunity. In late December of 2003, when Avon reported weaker-than-expected sales growth for holiday products, shares slid about 10% over just a couple of days. Sibilski saw it as a short-term hiccup, raised his fair value on Avon stock by $4, and recommended buying the shares.
Looking better will never go out of style for either Avon's customers, who are climbing the economic ladder, or for Estee Lauder's more affluent clientele. That's why the stocks, should they pull back some from their current lofty levels, strike quite a few investors and analysts as very attractive investments.