The Estée Lauder Companies Inc. (EL) Earnings Call Transcript & Summary

All right. Hi, everybody. Thank you all for joining the virtual Bernstein Strategic Decisions Conference this year. Thank you especially to Fabrizio Freda for joining us from Estée Lauder. I'm Ali Dibadj, Bernstein's former, I guess now, U.S. household, personal products, U.S. beverage analyst. I very much appreciate all of you being with us today in this new format. We're going to try to keep this as fireside-chatty as we can. By way of logistics, I have a set of questions, as true to my form that we'll be going through live, but the audience can also input some questions along the way. You'll have Pigeonhole. You can certainly e-mail me questions as well, and I'll do my best to toggle between them. Also, please note that at the end of this conference, you'll have a survey question, a couple of survey questions about what you heard. And this is good feedback both for us, but certainly, hopefully, for Fabrizio and his team at Estée Lauder in terms of what they're visioning. So before we get into question and answers, I think Fabrizio has a few words, and then we'll just start the conversation as usual. So Fabrizio, with your permission, let me hand it over to you.

Sure. Thank you, Ali. Thank you, everybody. It's a pleasure to be with you virtually today. So it is great to be with you today, and I want to wish Ali much success in his new role. I hope you are all in good health. And as the world begins to emerge from the effects of the pandemic, our hearts continue to be with those affected. Now since some of my remarks today contains forward-looking statements, let me refer you to our most recent company reports filed with the SEC, where you'll find factors that could cause actual results to differ materially from these forward-looking statements. Now to begin, our successful strategy built on multiple engines of growth is as vital as ever. Our diversified prestige beauty portfolio, categories, channels, geographies, brands, consumer segments and price points, give us many levers to fuel the business. In different moments over the last decade, we were driven by different engines, resulting in prestige beauty share gains each year. Our robust global skin care portfolio, vibrant online business, a broad exposure to Asia Pacific are the engines of this moment. These were powerful forces in the first half of our fiscal year, delivering terrific double-digit sales growth, and their significance has been further magnified throughout the crisis. For skin care, the desirability of the category has increased to even higher levels as self-care and regimens have risen in the importance. In this period of uncertainty, consumers are newly discovering and continue to return to brands and products they trust. Our latest innovation in hero franchises, like Estée Lauder Perfectionist, Clinique, Even Better Clinical, had performed exceptionally well. Our commitment to innovation in our hero franchises has not wavered, and we have an exciting pipeline ahead of us. For online, the tremendous global sales growth and accelerating conversion rates are seen across all demographics, are further strengthening the highly profitable channel for us. Our brand.com sites, brand boutiques on platforms such as Tmall and retail.com doors are excelling around the world. Online is an area where we have been investing for years, which has been a distinct benefit in this moment. And we have many strategic initiatives underway to further unlock the channel's potential. Asia Pacific continue to be a dynamic engine of growth with Mainland China and Korea moving from containment to recovery. Our business in Mainland China was a bright spot already in the third quarter, growing mid-single digit, and we expect it to deliver strong double-digit sales growth in the fourth quarter and beyond. We continue to advance our work towards a new state-of-art innovation center, which will open in Shanghai, as we aim to best meet the needs of Chinese and Asian consumers with local relevancy and local trends. Throughout the pandemic, we have been steadfast in our commitment to the long term that we aggressively work to mitigate impacts in the short term. I believe that the decisions we make for our people, our consumers, our communities, our retailers and our environment are so important as how we recover will inform the next 10 years. To this end, I have reorganized my leadership team in 4 groups. The first is dedicated to managing throughout the crisis with flexibility and agility, while the second is focused on health and safety protocols for employees and consumer as we reopen offices and stores. The third is concentrated on adjusting our cost structure throughout this temporary phase, while the fourth is wholly focused on the future as we anticipate new drivers for the business. Each work stream is moving our business forward in earnest. The progress in the 4 groups, as we update our 10-year compass, reinforces our optimist for the future of our business as a pure play in prestige beauty. The growth opportunity we foresee are incredibly compelling. Since the outset of COVID-19, I've been inspired by our employees' enduring compassion, spirit of collaboration and elevate sense of creativity. Next year, we will celebrate our 75th anniversary, as we have begun reflecting on all of the milestones our company has achieved together. And we are more intent than ever on becoming an even better company throughout this challenging moment. Thank you. And now to our chat time.

Thank you, Fabrizio. Thank you for that background. And certainly, in the 75 years -- almost 75 years of the history of the company, this must be one of the most challenging times in the company's history and for many companies.

Yes.

I want to dig a little bit into that and the challenges you're facing right now and how you reacted. So can you just talk a little bit about what you've seen, both in terms of the impact negatively from COVID, perhaps starting in your Asian markets, and then what you're seeing in particular from a rebound there and perhaps even starting in the U.S.? Just in broad terms.

Yes. What we have seen is obviously the -- in Asia, where everything started, we have seen initially a very strong impact in the -- particularly in the brick-and-mortar because of closures because people are going at home. But at the same time, we have seen an increase in online. And so in Asia, after this double event, meaning important hit in brick-and-mortar, but already an increase in online, then Asia started recovering faster than anyone else. And during the recovery, we are seeing the same trend. We are seeing a trend where the online increases stick, and the brick-and-mortar recovery is actually gradual even in Asia. But the online acceleration sticks, and so the proportion of the business between online and brick-and-mortar, including within the retailers, is evolving. And it's evolving in a situation where at least we assume that there will be a higher percentage of online business in the future also after the pandemic will be finished. In the West, we have seen the same phenomenon, but a bit deeper, meaning we have seen a deeper impact of closures and of brick-and-mortar and a moment of pause and then a start of recovery online. But the same phenomenon is happening. Now the online recovery is going to stay, in our opinion, meaning the percentage of business that will go online is going to stay after the pandemic for the reason that there have been a lot of new consumers going online. And interestingly, these new consumers are mainly 55 plus, so it's basically me. Our target group seems to have discovered the convenience of online commerce more than in previous normal life during this pandemic. Now many of them give us the intention to continue in a bigger proportion in the future. And so there are new consumers that now are online also in the West, and we see an acceleration of online also there, but as I said, a deeper brick-and-mortar hit in the short term during the pandemic. The other thing that we are seeing in that, obviously, has been a very difficult period for many retailers around the world, and so we see difficulties in some of our partners that we are supporting in the best we can. But obviously, this will result, in the West, in closures of stores and particularly in North America and in some European countries. And this will further evolve the balance between brick-and-mortar and online over time. And so that's what we're seeing. Now from a consumer standpoint, the level of passion of the consumer for beauty has remained completely unchanged. The level of interest in beauty is unchanged. The concept of luxury is evolving. And the concept of luxury is evolving from badging, show-off pleasure of having the best for yourself to quality, to creativity and innovation, new spirit, new ideas and to a concept of sustainability even reinforced, but I would say purpose. So the new luxury is a string quality of performance combined with the sense of purpose and sustainability and, most importantly, supported by amazing creativity, which frankly is coming further in the space of most of our brands in that sense. So the consumer is evolving also in terms of which categories, during the pandemic, they seem to prefer. Obviously, already before the pandemic, skin care was on a roll globally. After the pandemic and during the pandemic, this is further accelerated. I'm saying during the pandemic in the West and even during the initial recovery in Asia, we see skin care further accelerated. As you can imagine, with people being locked in their homes, we have seen make up, at least in certain areas of makeup, mainly color makeup, further decreasing the growth, further decrease in the business, and the same for fragrances where hair care was more stable and more resilient. But skin care was the big winner. Face makeup was the other big winner, meaning foundation, concealers. And with our team, we are calling this. We have gone from the moment of the selfie generation to the Zoom generation. And the makeup is obviously -- and skin care moving from the selfie idea to the Zoom idea. And obviously, on a Zoom, there are some categories within makeup, for example, which are doing better. Can you imagine brow or eye are doing better than lipsticks or other category like this? And again, all this is temporary. And my point of view, actually, our strong facts on makeup is that makeup is cyclical. And in this moment, there is a cycle, obviously, accelerated by the pandemic where color makeup in certain category is softer, but this will come back and will accelerate as life normalize. So the last thing on the consumer I want to say -- sorry, the last thing on the company I want to say is that also, what we have gone through is a big containment effort. During our Leading Beauty Forward, we have been able to move our company more into variable cost, less fixed cost. And during this period, we are benefiting of this higher agility in cost to try to mitigate the short-term cost and to try also to move our resources toward the new drivers of the future. I think we are able to do this faster than we could have done it without Leading Beauty Forward.

Okay. This is great. This is great. It sets up a lot of things we can dig into. The first one I wanted to dig into a little bit is online. And clearly, what Estée Lauder has done over many, many years has really ramped up online, particularly in Asia Pacific, but really globally. Are there any changes to your strategy for online that you think you need to do, given the perhaps permanent consumer shift more towards online?

Yes, there are -- first of all, our online is very strong, meaning we have strong technology, the base of our e-commerce. We have strong relationship with our retailers around the world to do better retail.com. And we have a strong relationship with all our platform partners, like Tmall and others around the world. So -- and now pure plays are also accelerating a bit stronger. So we have strong market share, first of all, on online everywhere in the world in every single platform. So what is changing is, first of all, we -- the consumer experience online is changing, helped by technology. For example, virtual try-on is going very well. Virtual trust has been a big idea for us. Imagine that in China, we have been doing what we call social selling, meaning that when the stores were closed and our consultants were locked in their homes, they went to do clienteling online using the online of the retailers or our own, depending on the situation, to continue selling and continue having relationship with their consumers. This worked extremely well. That's one of the reason of China fast recovery, and we never lost our clients in the shadow. We were with them all the time. And so all these -- and these are -- this is possible by a technology that we call consumer chat online where you can follow your client, have a chat like you and I are having now in -- with the products on our brand.com and in other forms of dot-coms. So this new technology are changing and evolving. We have a strength in this area, particularly much stronger than the many of the more indie competitors that do not have, at least today, this -- most of these capabilities. So this is an area of evolution. The second area of evolution is in logistic, in fulfillment. I mean the acceleration of online around the world has been extraordinary. And so we had strong fulfillment capabilities in every country, and we are further reinforcing them. And so we are investing in reinforcing mostly the capacity and the ability to react and the flexibility of our fulfillment capabilities, which again are revealing to be a strong competitive advantage. We basically didn't have big issues or big delays despite the -- in this moment, our online, as we communicated during our quarterly call, we are speaking triple digits in every single country of the world. So obviously, in order to get this sudden acceleration, you need to have strong fulfillment capabilities, and that's the other area of investment. And then the third area of investment is the area of taking this moment to accelerate online penetration in the countries where online penetration was not very strong. As you know, our strongest online penetration are in U.S., U.K., China, which are the biggest market for us, were online in the 25%, 30% already before the triple-digit acceleration. Now the countries like Italy or countries like Canada or others, the online penetration was much smaller. So what is changing that we are taking this opportunity to further accelerate that in a big way. And as I said, the reason why this is working because there are so many new consumers that entry online. Importantly, the new consumers are new to online, but also new to our brands because that in the online environment, having -- being our market share stronger than in some brick-and-mortar situation, particularly in some countries in Europe, for example, we got -- we don't got new consumer to our brands. So a very interesting trend.

So Fabrizio, do they -- when the consumers come online, do they shop at the same places? Or are they shopping places where perhaps you're not? I know we've always had this dialogue about Amazon's beauty portal, for example, or other places where you could show some presence. Does that change at all in this new normal, as they call it?

I think they shop more in known places where they're looking for their brands and they're looking for new experiences. So the consumer in this moment are not very exclusive in the world of online. They are really searching for new experiences. So we have seen new consumers, so increased traffic in our online. I'm sure others have seen the same. But the beautiful insight is that we have seen a big acceleration of conversion, meaning out of 10 consumers that visit our sites or retail.com with our partners or our stores in Tmall, et cetera, in all these visits, we see more of them buying and more of them coming back. So this combination of increased traffic and increased conversion is the point of strength. And yes, there is a lot of competition out there. But frankly, the consumer are much more willing than before to navigate and discover online. And so I see the competition actually more manageable than in the future. And particularly, what we see online is that the consumer has 2 needs in this moment. One is replenish the product they love, and they are more difficult to access today. On these ones, like buying their Estée Lauder Advanced Night Repair that they're missing because they've been 1.5 months or 2 months locked in their homes, their conversion is extraordinary. They come and buy online to replenish instead of waiting for when their brick-and-mortar will feel comfortable or safe to them. But then the interesting thing, they also have maybe probably more time in this moment, but they have more time to discover new things. So they navigate, explore. And in these new customers, new exploration, new navigations, the ability to retain them and to convert them is about, again, creativity. Quality branding is the power of the brand. And we see the power of the brands and the power of our hero product in that online environment even enhanced.

And Fabrizio, are you seeing in this navigation and this ability to take more time to search online any more price sensitivity?

There have been a lot of promotionality in different parts of the world, depending on the months in this period. So obviously, the consumer have taken advantage of promotions in certain parts of the world in certain moments of these lockdowns. But I don't see personally more pricing sensitivity at this point of time. Now obviously, we can speak about the risk of recession and what will be the attitude of the consumers on that. But during the lockdown, frankly, I didn't. Actually, I saw the opposite. And -- but there is an explanation. So I don't pretend this attitude to stay in the long term. But the consumer, during the lockdown, didn't spend a lot of money for other things. They didn't travel. They didn't go in vacation. They didn't go to restaurants. They didn't go anywhere. So they had some available income, at least the one that have not lost their jobs, some available income for extra things. And that's why I believe there was all these bigger interest and more time and a bit more available income, again, depending by consumer group, that we saw it coming online in a big way.

Okay. So I want to spend a little bit more time later in terms of top line growth and industry growth. But one of the questions that always comes up about online is, gosh, the margins are so much better, right? So as there's a bigger shift online, can you talk a little bit short term and long term in terms of the margin impact of that shift and COVID on your numbers?

Yes. In the long term, there is no doubt that the swing online will be margin accretive to our company. That's not true for everyone in our industry. It's not true depending also on the scale of your brand and your operation because the profitability online is also very much linked to your scale online and to the investment you have done for years. We have done now for the last 10, 12 years, significant investment online. We are today in a very good position. So today, our profitability online is accretive to the company, and the proportional and gradual swing to the online sales is going to be good news in terms of profitability improvements over the long term. In the short term, our impact of the closure of brick-and-mortar, particularly in the West, meaning Europe, U.K., U.S., Canada, has been brutal. As you know, the brick-and-mortar, it was at minus 90% in April in the U.S., as an example, the market, not only Estée Lauder. And so in that situation, since a lot of costs are still in the brick-and-mortar, the impact of margin, obviously, on the total had been very negative. And I want to clarify, as we explained in the call, that our quarter 4 will be worse than quarter 3 in terms of margin compression in the short term, temporary margin compression. Also because in quarter 4, on top of the lack of leverage of our expenses in brick-and-mortar around the West, particularly, and some Asian countries where there is not yet recovery, we have the manufacturing negative impact of cost because as you can imagine, when the factory are closed for months and then the people are still paid and there are all the costs of the factory there, there is a temporary negative impact on gross margin, which is very, very, very significant and will be very significant in quarter 4. Also because quarter 4, there will be a combination of this negative impact gross margin and the fact that the reopening of our factories that now is in place. By the way, good news, all our factories around the world, all our distribution as of today are open and functioning. However, they are functioning with new rules of social distancing, timing, because our priority is and will remain the protection of our employees in the best possible way. Our factories looks amazing, by the way, in that sense today. And our employees, for all our feedback, feel very comfortable, and we are proud of that. However, in the short term, we had lost productivity doing that. And so the combination of closures and diminished productivity has a temporary cost of margin. So the online margin is actually the mitigating factor of the other points in this moment. So yes, there is, as we speak, already strong positive impact on the online. But I want to clarify that while in the long term, this will be very visible, in the short term, this is not going to be very visible because of the negative impact on margin in the short term, which I was explaining.

Okay. If I still had an Estée Lauder model, I think you gave me enough clarity for the next quarter to be punitive on margins. So you mentioned the industry and competitors. Let's take a step back a little bit. What do you think the industry grows this year? And when do you think it gets back to kind of this 4% to 8%, 5% to 6% sales growth in prestige?

I think that the -- again, those are estimates looking at the market. I believe that this -- the recovery will be gradual. This is now evident. And there are still many unknown factors to judge the timing of the recovery. So today, I am very optimistic and very positive on the fact that there will be a recovery, that the recovery will be full, that the consumer will come out actually stronger in terms of interest for beauty in general and luxury beauty with the new definition of luxury I just gave in the long term and that we will be ready to enjoy that recovery. Also, I remain very positive on the fact that our market share of this market is increasing as we speak. We're gaining market share. We've been gaining market share in quarter 3. We are gaining market share as we speak, and we will continue to gain market share in the long term. What I don't know is that the speed of this recovery and how fast we'll go back to normal. Our current estimate is that the first 6 months of our next fiscal year, or if you want, the July-December period is going to be gradual recovery of brick-and-mortar and a further acceleration of online. And the gradual recovery of brick-and-mortar will be, in some markets like the U.S., be combined with closures of brick-and-mortar. And while in other place of the world like Asia, there will be much less closures, but still, there will be a gradual recovery. To support that belief, I look at China today. China today is already growing at double digit, is already going in the direction of where we came from, meaning from the strong growth we had in the past. But the composition, even in China, is different. The composition is brick-and-mortar is not yet back to 100%. Even in China, brick-and-mortar is still well below the previous year, but online is so much stronger than the total. It's double-digit stronger. So even in China, we see that the recovery of brick-and-mortar is gradual. And I assume this will be even more prominent in Europe, U.K., North America, meaning the graduality will be even more evident, and as I said, combined with some closures. But then as of calendar year '21, I assume that if there is no second wave, we are going to see some stronger and faster recovery, very exciting. If there will be a second wave, and we don't know, this may be again delayed by some partial temporary further closures in some markets. Interestingly, studying the history of second waves in this kind of situation, second waves tend to be more local. They happen in certain areas and tend to be less global. Also because, as evident in these days, certain communities, certain countries have a different way to react to the virus, a different way to protect from the virus. And so the risk of second wave is different by country, by part of the world, and that's why even less predictable for us. But I'm pretty optimistic that as of calendar year '21, we are going to see a global recovery of the market. And then finally, your question was the number, 5%, 6%. I definitely believe the market will go back to an ongoing long term 5% to 6% growth per year after this crisis will be finished.

Okay. Okay. So we talked earlier about a few consumer behaviors that are going to change and probably sustainably change. So online is one example of that. One of the things that we're seeing in many different industries is this desire of the consumer to look more for health and wellness, to look more for better-for-you in some sense. Can you talk about Estée Lauder's positioning in that, clearly with Origins and Aveda, maybe in others? But how do you think about the evolution you have to make if that indeed becomes an accelerated trend? Does there need to be more M&A? Do you have to refocus your R&D? How do you think about that?

So I have to say, we were already in this direction. So the consumer is more interested in self-care, in regimen, in skin care, in safety, in the right hygienic standards and is more interested in the area of skin care in performance, meaning they have new very clear expectation of high performance. Now the brands in our portfolio which are performing that are many. Well, you mentioned Origins, Aveda, which are very well positioned for the second kind of trend, which is sustainability, naturality, which is safety, which is also important. But they are 2 trends, and they have some of their lab -- not every consumer is looking for both trends. The trend number one is performance, safety and really quality in a sense of confidence in the product. In this first trend, our brands like Estée Lauder or La Mer are flying. I mean our best-performing brands are these brands, and they are having amazing traction because of their performance because they also have trusted hero products, which are becoming part of the everyday life of many, many global consumers. And the level of loyalty and repurchase rates of these brands are outstanding. Now loyalty and repurchase rates, high repurchase rate in the 50%, 60% of consumer that ever try it are already extraordinary during normal times. But in this time, in recovery, they will play an even bigger role because in a recovery mode, where we see the consumer first go back to their habits, to their area of comfort and then experiment again, so all our hero product in the space are really well positioned there. And then you're right, we have some natural brands like Origins and Aveda, which are accelerating at getting new consumer because of the trend of sustainability and natural. But all our company, all our brands have a sustainability model by now. And maybe they are different. It's not only about naturality or product, there are other sustainability model in the S of ESG, more in the social area. By the way, it's interesting. Before the pandemic, ESG, environment, social and governance, there was a very high on E, environmental sustainability. This is obviously staying. But the S is further increasing and accelerating. The importance that the consumer attribute to the social impact of brands, I think, is further accelerating. And our brands are well -- very well positioned in this. Then in terms of R&D input, as you said, yes, we are going further investment in R&D. The most important goal in terms of relevance, but also in terms of amount of investment, is our new R&D center in Shanghai where we are doubling down on our ability to design products for the Chinese consumers with local relevancy for the Asian consumer because this is going to be an R&D center in Shanghai for Asia. And we are taking this investment to get better local data, better understanding, but also better local clinical testing capabilities, local ability to test on local skin and local ability to have joint ventures with university, with other research centers and to get technology and R&D investment going in the region. This, obviously, is not new. We have done it in the last years at a smaller scale, but the results has been so promising that we are ready to scale it up and go to the next level. This will be particularly focused on skin care and on face makeup. And those are the 2 areas where the consumer today have more expectations. I will stop there. But if you want to go more in depth, I can, but those are the main points.

No, no, I appreciate that very much. And if you think about R&D, there's obviously home-grown R&D, right, which is your own development. And then there's also the M&A, so the acquired R&D, so to speak. And I'm glad we mentioned Origins. I think that's one of the few brands you did not buy. I think they're -- most of the other ones, you did. How do you think about M&A for meeting the new consumer needs? So DECIEM, obviously, has been something you guys have been involved with. [ Classieré ] is something out there that everyone thinks everyone's looked at. How do you think about those brands and what M&A means in this context today?

Yes. I think that obviously, we continuously look at M&A for opportunities. But R&D is not really the area where we need a lot of support from acquisition. Normally, many of the brands out there, particularly makeup, but many of the brands out there are using third-party manufacturers. So they outsource their R&D. You don't buy these brands because they have ingredients, formulations that you don't. We -- actually, it's the opposite. We buy brands that then can benefit from our R&D unique technology. So R&D is more an element of leverage there as than something we acquire for. And so we look at the so-called indie brands or new brands of the last years were a tremendous success around the world. In this moment, frankly, the one of them that are mainly focused on brick-and-mortar are suffering. And one of them which are more of online pure players are continuing doing well. And so the world has been a bit divided into these 2 directions. And then the -- our priority in M&A will continue to be also to look into the Asia brands development. So we are very proud of our recent acquisition of Dr. Jart+ that, by the way, is our biggest skin care acquisition ever. And it's a Korean brand, and this obviously, with the recovery -- after the recovery, we have great expectations from this brand, which is a good example of how our acquisitions continue to be focused on the strategic opportunity in that moment. In this moment, having our latest acquisition being an Asia skin care brand is exactly an acquisition in the core opportunity of today, as you have -- as you know from my description of the overall market opportunities in this moment. So we will continue looking at acquisition in this way with filling clear strategic opportunity areas rather than buying for R&D technology, which frankly is not our priority.

And Fabrizio, are you seeing better opportunities today given what's happened from an economic perspective that you can opportunistically go after? Or has the valuations really not change in these smaller indie brands?

I mean, my point of view, the valuations are changing. People may not accept this, but the -- but in general, we don't look at acquisition in a tactical way based on short-term valuations. We look at it as filling strategic opportunity in the long term. So yes, we will continue. And so if your question is what are the new M&A opportunities, frankly, the new M&A opportunity are coming from the new trends that we are describing, meaning the most interesting M&A opportunity will be in the area of skin care, will be in the area of brands with strong online capabilities, will be in the area of brands that have traction also in the East and will be opportunity in area of brands which have a reasonable pricing position and also, importantly, of brands that have the ability to have long-term profitability. So the idea of these brands that built in the last 4 years without visibility or profitability, I don't think these times are any more the times for that kind of platforms. But there are new opportunities that are linked to the new drivers that will appear to be very important in recovery.

Okay. Yes. In infinite times, profitability as a multiple is always difficult for people like me to swallow. So one thing we haven't talked directly in the past little while today is travel retail. And clearly, that industry has been just overturned given what's been going on right now. How do you see travel retail evolving? And what's the impact on you, not just on margins, but on your growth cycle going?

So that's a great question. First of all, long term, and then I'll answer short term. Long term, I believe that travel retail will remain one of the most exciting channels for luxury in general and luxury beauty in particular. And this is going to come back. And obviously, travel will come back. But travel will come back also in different forms. Second, also in travel retail, the phenomenon of online that we call retail is accelerating extraordinary. Today, it's very interesting what we observed. I always spoke about TR as 2 drivers. TR is driven by traffic, and that's not a good moment for that, and it's driven by conversion. And that's actually an extraordinary moment for that. We are seeing conversion numbers go through the roof in this situation, obviously, on very small traffic for the time being. But directionally, that's interesting. And this is driven by pretail, meaning by the possibility of buying online when you have the ticket before you travel. Now this pretail phenomenon is, I think, is going to be even more relevant when in the beginning, before we are all more comfortable with traveling again and the virus will be completely defeated -- that will happen, by the way. But before the moment, we will be more prudent in traveling. And being more prudent, maybe we want to go less to the store with a lot of people buying, and we prefer to buying online before traveling. And so once we will experiment with this in the moments of less comfort like today, then again, some of this will stick. So we are assuming that there will be an acceleration of pretail, driven by the more prudent approach to travel over the next several months. So in the long term, I envision a travel retail channel that will go back to more normal traffic. And this may take time and may take a year or more, but will happen. And I also envision a higher conversion rate than usual that will make the travel retail, although the traffic may not increase for some time the way it used to, the conversion will. So I expect travel retail to go back to more normal level of relevance and growth at a certain moment, but with a different mix of traffic and conversion, driven by the online phenomenon. So that's my long-term positive vision on the channel. In the short term, we see already some of this happening. In this moment, first of all, the travel retail in Europe and in the Americas is basically minus 90% the traffic, as you know, from the number. So it's basically all closed. And by the way, this will have a big impact on our quarter 4 because in our quarter 3, we had some travel retail challenges in the East, but we didn't have a lot of travel retail challenges in the West, while quarter 4 will represent the worst quarter in that sense. And then we expect gradual recovery as of next fiscal year. But the -- so the West is closed and will reopen later. But in the East, we already see some phenomenon. For example, in China, international travel has not yet started in any significant way, but domestic travel has. And we see already areas for internal domestic travel, which are duty free, like Hainan and the Hainan Island where tourism is already increasing because it's the way they've decided they can have a moment to relax in this moment after the virus internally. And we see sales there already been pretty strong. We see sales there. Today, what is open is Korea. Internal travel is open and numbers are very strong. Hainan is open, numbers are very strong. Macau, Hong Kong are open, and number are starting to recover. So what is opening is showing impressive conversion rates and increasing traffic. So next, in the short term, I believe this will continue to be a challenge and will be -- the recovery will be -- the recovery of traffic will be very gradual. But in the longer term, we will see a more moderate traffic, but much higher conversion that will bring back travel retail to be a key driver of growth and, most importantly, an accretive driver of growth to the company, and thanks to the pretail, even more accretive.

And so do you see the future state of travel retail driving any type of mix of category that consumers purchase, that travelers purchase or brands? And what does that mean to your market share?

Yes. So this is, frankly, all favorable. What we see is that in this moment, meaning in a moment where the travel retail which is opened is mainly in the East and the consumer by mainly in the East, obviously, you see a much stronger performance in skin care, in travel retail and less in makeup and fragrances. But this obviously will change as soon as the global distribution is changing. Because to be clear, the travel retail Asia has a higher percentage of skin care even in normal times. The travel retail in Europe has the highest percentage of fragrances, and the travel retail Americas is very strong in makeup, et cetera, et cetera. So however, in Asia, we see -- we saw before the crisis already an acceleration of makeup and fragrances that will continue during the normal times. But in this moment, there is an overproportion of skin care. The -- but when travel retail will normalize, we believe that all the categories will get a positive growth. So more than a difference by category, what you will see is a difference by brands, meaning in travel retail, only the strongest brands are really able to generate a level of productivity that make them chosen by the travel retail airports, et cetera, to be there. So scale matters in travel retail. It's a -- travel retail is a channel where scale is very important. And that's why we believe that most of our brands will have today and will continue to have a relative advantage in travel retail. The other thing that matters in travel retail are hero products. When you travel, you are less willing to experiment because you buy product either for yourself, but then you try things you know or for gifting, and then you don't want to be wrong in your gifting. So there is much less experimentation in travel retail and much more search for heroes, for well-proven product. Now our market share of heroes is extraordinary. You heard me speaking about this strategy now pretty overtly in the last 3 or 4 years. We built it because we knew that our 2 most accretive channels, online and travel retail, were driven more by heroes than by enormous amount of SKUs. And that's why we have, over time, strategized in that direction more. Now we are in pretty good shape. So we see this to be further emphasized. And last, travel retail is also driven by what we call the high-traffic moments. There are moments of the year where people travel more. But most importantly, travel is composed by touristic travel and business travel. Business travelers have more or less the same purchasing attitudes during their own business trips, but tourists don't. Tourists are much more driven by specific peak and valleys or moment where they're willing to buy. And so today, we have a very sophisticated ability. We have all the data point to know exactly which moment the consumer buy, what and how much traffic there is in that airport, what are the most interesting SKUs that they will buy in that airport depending on the profile of the customer who is coming to the airport, the more Russians, Middle Eastern, Chinese, Indians. And depending who they are, where they go, we know exactly what to put in exposure, what to put in retail, which kind of stocks to have. All of this has become much more sophisticated, thanks to data, and this will be an advantage over the long term.

Okay. So I have time just for a couple more questions to get to. One of them is more broadly about permanent consumer behavior change. And I guess if you were to step back and close your eyes and say, these are the 1 or 2 permanent consumer behavior trends Estée Lauder is most concerned about, right, that would really impact us negatively and how I'm tracking those, what would those be? Are there a few that really come to mind as a concern, whether it be trade down, whether it be really broad recession? What are the types of things, post-COVID, consumer behavior changes that you'd be most concerned about or we as investors should be most concerned about?

Yes. The one we are concerned with -- and again, in Estée Lauder teams, the concern means actions normally rather than just being worried. So the one which are concerning us and we are acting on are, first of all, the consumer be more concerned, at least in the short term, with safety and the potential impact on that be -- of that concern on their willingness to be in brick-and-mortar experiential situations in the future short term. And then what's the impact of that even when the virus will be gone, okay? So for example, what are we acting here? We are trying to make our in-store experiences really safe. For example, there is a team which is working on what we call confident retail, meaning the future of retail that will be designed in a way that a consumer will be completely comfortable. So that's one trend. And again, instead of giving you too many details on that, I'll speak about another one, but you need to imagine that's obviously important to us.

I'm imagining drive-through Estée Lauder counters.

Actually, that's one. And you can imagine omnichannel activities more connected online with the brick-and-mortar. You can imagine that the -- in our store, we have testers, things that you need to touch to try products. You can imagine, at least in the next month, that's not exactly what every consumer will want to do. And so for example, what's the role of mini-samples instead of testers? What's the role of safe retail in terms of dealing with retail like we deal with our factories? So hand sanitizer, mask availability, distancing in a certain way. How do we deal even in a store, instead of touching the face of people with virtual makeovers, examples where you can interact on a video instead of the first, if you choose to, et cetera, et cetera. So this is all -- and some of it is temporary, like the idea of touch. I think at a certain moment, when the virus will be defeated, human being will go back to normal social relation, and that's my also personal hope. But in the meantime, we are developing all these elements, and we are keeping in mind that even when the virus will be defeated, some of this will stay. And we are trying to learn with consumer what will stay and what will be relevant for the long term. So this is a worrying theme. The other worrying theme, you spoke about recession and what happened in recession. It's evident that during recession, when there is a very strong impact, a certain part of the population is less hit by recession. And this part of the population is -- tend to be more into our target group. And so as usual, the impact of the recession on our business is going to be reasonable versus -- when you look at history, there is an impact, but the impact is not so profound. What worries us is that in this moment, the potential short-term impact on recession is strong and is very deep. And so we are studying what could be the short-term consequence in terms of the trading down of consumers. And for example, actions in this area is where trade down is at risk, we are reinforcing our brands, which are the entry price point of prestige. You remember probably, we already, I think, had a conversation in 2008, 2009 period of what happened to us, our brands like Clinique or M.A.C actually grew in that period and in certain markets like in the United States. So we have a portfolio where we can mitigate the risk of recession, creating a trading down with reinforcing our entry price point brands. By the way, some of these brands have the scale and have also the positioning to fit the new consumer needs pretty strongly. So we believe that's actually something we could turn a problem into an opportunity. Another thing that worry us is regulations and around the world and how the regulation will be impacted by the changes. And obviously, also, we remain concerned with trade issues globally that may emerge out of this. And although, as we discussed in several times, our high gross margins model put us in a condition to manage possible trade issue, trade problem, trade tariffs in a manageable way. So those are our main concerns in this moment. But the biggest -- more than a concern, the bigger question is the shape of recovery because we can have -- obviously, this impact on business has been very, very tough. And -- but is -- the impact of this pandemic at the end is a temporary or is a onetime event, hopefully, but has all the characteristic of a onetime event, maybe not short, but it's a onetime event. The market share recovery is going to impact our business for the next 10 years. And that's why in my prepared remark, I explained that I've created a team of people with me, which is really 100% focused on the future drivers and how we're driving this. Because probably the most important thing we can do, on top of taking care of our employee, of our consumers and mitigating our short term cost, the best thing we can do is put us in a position to grow market share in the recovery because that's going to be a long-term net present value for all our shareholders.

Yes. Fabrizio, this has been, as usual, a very informative and dynamic discussion. I very much appreciate you spending the time with us. We could probably talk for a few hours. And if social distancing goes away, perhaps we can do that more close to each other. But I really want to thank you so much, not just for this session, but for the other sessions we've done together here at the SDC and beyond. And you've always been a pleasure to work with and a pleasure to really give us a view, not just of Estée Lauder, but really a visionary for the whole industry. So thank you so much for your work. And perhaps, we'll see you again here next year in a little bit of a different format.

Thank you very much. And again, all the best for your new role, and thank you for all what you have done, not only for all of us here, but for the industry in the last years when we worked together. Really impressive. I always have a lot of respect for you, for your thinking, for your ideas. And thank you to all of your colleagues as well.

Very kind of you to say that. Thank you so much, and we'll talk soon. Thank you, everybody, for joining.

Bye-bye.

Bye.