China, the Next Engine of Growth for Estee Lauder

Estee Lauder (NYSE:EL) makes premium skin care, makeup, fragrances and hair care products and sells them through upscale department stores, perfumeries, and prestige salons and spas. These formats emphasize exclusivity, which helps defines them as luxury beauty and personal care products. The company competes with well-known companies like Revlon (NYSE:REV), L’Oreal (PINK:LRLCY), Avon Products (NYSE:AVP) and P&G (NYSE:PG).  Estee Lauder’s brands include Aramis, Clinique, La Mer, Aveda and designer brands such as Donna Karan, Tommy Hilfiger, Michael Kors and Sean John.

The slow pace of economic recovery in US with unemployment levels still hovering at historical high levels of close to 9.8% (as of November 2010) and Europe struggling with possible default of sovereign debt by Portugal, Ireland, Greece and Spain (PIGS) and low industrial output growth at around 2% both leading to a devaluing Euro, creates a tough environment for a brand that appeals to the luxury segment like Estee Lauder. That being said, recent data points have turned positive, and we are seeing signs that confidence and spending picked up over the holidays.

While a recovery in US consumer spending will certainly help Estee Lauder, we feel the true engine of growth will come from abroad … and from China in particular.

China’s Consumers

China’s economy has been growing in double-digits over the past decade. According to Bain’s ‘2009 China Private Wealth Study’, the number of Chinese high net worth individuals (those with more than 10 million RMB or  $1.5 million) is expected to grow by 6% year-on-year. ^[1] But the Chinese aren’t just earning more, but spending generously as well. In US alone, over a million Chinese tourists spent over $7 billion on luxury products in 2010. (Keep Chinese consumer spending at home, Global Times, Dec 30th, 2010))

Our optimism for Estee Lauder is however based on the fact that while the Asian consumer has always been a patron of skin care products, men’s skin care products have recently struck it big with the Chinese male and this presents an excellent opportunity for growth to Estee Lauder. Not only is the Chinese men’s skin care market touted to reach $270 million in 2011, exceeding North America at $227 million, it is also expected to grow at 29% year-on-year through 2014, compared to North America at 5.7% and Europe at 7.9%. ^[1] Skin Care constitutes over half of our $53 Trefis price estimate of Estee lauder’s stock. Given the rising affluence of the Chinese and their preference for luxury cosmetics along with the Chinese male getting increasingly involved in skin care, we see a window of opportunity for Estee Lauder.

Skin Care Market Share

We currently estimate Estee Lauder’s share of the global skin care market to grow from 6.2% in 2010 to $6.7% in 2012 eventually reaching 7% by the end of our forecast period. However, the Chinese skin care market dynamics make us believe that Estee Lauder could reasonably gain 7.2% by 2012 and eventually touch 8% in the coming years, leading to around 6% potential upside to our current Trefis price estimate of its stock.

The above assumes an increased focus on Chinese markets in terms of a more customized product offering, and media and advertising assuming no changes in the government policy. As of today, China slaps excessive customs duties on imported products, especially branded consumer goods, which end up making them almost 50% dearer than those available in overseas markets.

While this doesn’t deter the Chinese tourist who is abroad on a shopping spree, it does adversely impact the sales of luxury products within China besides causing a loss to Chinese govenment’s tax revenues. While Chinese products are everywhere in the world, such taxation has resulted in China’s trade surplus being close to $196 billion in 2009. ^[2] China’s excessive trade surplus with the developed world (US, UK, France etc) has been a concern in the international economic stage and going forward, we can reasonably expect some relaxation to Chinese customs duties. What increases the likelihood of this is the fact that more imports into China will ease deficit pressures on foreign countries and also contribute to China’s tax revenues since lower retail prices of popular foreign brands in China will stimulate greater consumption of these brands.

If China decided to relax its customs duties, this could result in Estee Lauder gaining close to 8% market share of global skin care by 2012. If this trend continued and Estee Lauder secured 9.25% market share by the end of our forecast period, this could lead to 15% potential upside to our current $53 Trefis price estimate of its stock. However, heightened competition in Chinese skin care market in such an event would warrant increased spending on marketing and advertising by all players, which could erode away the EBITDA margins in the short-term (2011-13), but a significant upside is almost unquestionable.

You can drag the graph above to see the impact on the stock price.

You can see our detailed $53 Trefis price estimate of Estee Lauder’s stock here.

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1. The challenges facing luxury goods, Bain Online [↩] [↩]
2. ref:1 [↩]