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

Okay. I can see the timer has started. So we're going to kick things off without any further ado. Good morning, everybody. Thank you for coming on. It's a busy room, but there are a couple of seats I think, scattered around, especially at the front. So please feel free to take one. For those of you who don't know me, my name is Callum Elliott. I'm Bernstein's U.S. HBC and beverages analyst. And I'm delighted to welcome Fabrizio Freda, who needs not much introduction as the CEO of Estee Lauder Companies. Alongside Fabrizio, is Guillaume Jesel, who is the President and CEO of Tom Ford and Head of Luxury Business Development. I felt like I might have massacred the pronunciation of your surname there, Guillaume. Just a quick housekeeping item. On the screen behind me, we should have a safe harbor statement for the Estee Lauder Companies regarding forward-looking information and non-GAAP disclosures of which you should all be aware. With that out the way, though, Fabrizio, Guillaume, thank you for joining us.

Pleasure. Good morning.

Morning.

So Fabrizio, I think we need to start with growth. And 2 years ago, when you were here with Peter Jueptner, Head of your International business, we talked a lot about your compass, your sort of long-term strategic road map. For the past couple of years it has clearly seen a lot of volatility. So as you strategize today on beauty industry growth for the next several years, what do you think will be the primary drivers of growth for the beauty industry and prestige in particular for your business? And how has that changed over the past few years since we had that conversation with Peter?

Yes, first of all, the key concept is there's still a lot of growth in front of us in the industry. This is a high-growth industry. The prestige beauty part is really a high-growth industry. There are so many long-term secular activities and changes which are happening that will, in my opinion, confirm this for the next 10 years. It's not only a short-term thing. So let's start from, first of all, the markets. We see 3 blocks. First of all, emerging markets other than China. This group of markets, we look at them altogether. And altogether, they are a very big source of growth for the future, even currently, but also projecting it to the future in the compass sense. These emerging markets are growing for several reasons. They're at different stages of their development, and I will make a few examples, but they are all growing because the middle class is growing, because the per capita consumption of prestige beauty is growing, because the categories are growing in different ways. For example, some cases, there is low penetration of skin care. This is increasing or lower penetration in makeup, or in fragrance, this is increasing. So there are different category development stages. And they all are growing because of the overall growth of prestige versus mass. So for example, take India as an example. India has about -- today, 10% of the total industry is prestige luxury. But this part of the industry is growing double than the total industry. So you can easily see how overtime, this becomes 20%, 30%, 40%. The same phenomenon happening in China where in 2017 to today, the penetration of this has more than doubled in terms of the luxury versus total industry. There are many examples of that. So examples of our -- for us, our emerging markets is places like India where we have very high market share, where the growth is very strong, where we are penetrating the market in terms of distribution. There are still a lot of opportunity, there is -- infrastructure is being built. That is -- there is a lot of growth also in the middle class. But the key area is that the online is playing the role -- online commerce is playing the role to make the acceleration of this emerging market much faster. The reason for that is that historically, emerging market, we are growing at least in luxury at the pace of infrastructure because the infrastructure or luxury had to grow ahead of the market. Now with the online, the ability to reach the consumers which are ready to buy is immediate and take India as an example, the arrival of one of our partners, which is Nykaa online business has changed completely our ability to penetrate. And so our market share now is in the 40% plus, 40% plus of the prestige, so very strong position to grow. So emerging markets will continue to grow. We have a team that work on them. It's a very, very strong team. They also connect them [ online ]. The second is developed market. Developed markets are growing very fast. Frankly, one of the consumer industry, which is growing the fastest. The driver of developed markets growth is, for example, in skin care is regimens. People are using more regimens for multiple products or the age of usage of skin care is getting younger. Fragrances. Fragrances have developed -- in developed markets has gone from 2, 3 fragrances in home to 6, 7. So the amount of fragrances in home is -- has increased. And because of these brands, they offer collections a much better ability to penetrate the market than the single brands, et cetera. And then importantly, the interest -- again, the interest in high-quality prestige luxury beauty products has increased. So again, also in developed markets, the percentage of growth of prestige is faster than mass. And so the development of the prestige market, the percentage of the total keep increasing in the correct way. So this from a geographical standpoint. The compass from category standpoint, we still believe skincare as 3 years ago is going to be the fastest-growing category. Now this is a positive because skin care is also the one with the best P&L structure, particularly with the best gross margin in the overall. And so the fact that skin care will continue to grow ahead of the average is actually good for profitability in the entire industry. The -- skin care is also growing, as I said before, because of regimen usage, but also growing because consumers are really seeing the reason for using skin care in different area. There is anti-aging, probably if you followed our innovation program. Anti-aging is turning into age reversal and technology is going from anti-aging to age reversal. Then there is the instant benefit growth, which is for young consumers that prefer, for example, benefits like luminosity, glow, benefits, which are immediate, which are happening now and that's one other aspect. And then finally, the growth of care in terms of the expertise consumer is changing. The amount of knowledge about ingredients and all these expertise in making consumer much more capable of driving regimens, instead of using 1 product, using 3 products for night, 3 products for day. And then what is increasing overall in the market is the consumption of night products and the use of product during the night cycles. So this is driving skin care. What is driving makeup is many aspects, obviously, in many markets, but the contour makeup, for example, is winning in Asia, makeup -- parties makeup doing very well in the West. So different markets drive different part, but makeup is becoming particularly tied to looks and the different looks by different occasion is growing exponentially. And finally, fragrance is -- I commented it's probably one of the fastest growing categories because of the amount of product in every home. Consumers are using fragrances for different occasions, for different moments. I still remember my father had used 1 fragrance all his life like probably your fathers or mothers as well. But the -- but I already was a revolution, I used 2. But now children use 7, 8; 1 for every kind of occasion for every moment, et cetera. That is a big change of the category, as you can imagine. And this is dramatically increasing the overall consumption. And this is the category which is the biggest percentage of business in prestige luxury versus the total. So it's driving also the growth of this category is also driving the mix between prestige and mass in a very positive way for prestige. So those are the big changes. The last maybe I want to mention is channels. Channels continue -- the mix of channel continue to grow. Obviously, online continues to accelerate, to increase the percentage of the total, now on average online is more profitable than brick-and-mortar at least in this industry. So this is a positive growth. Travel retail continue -- will go back to growth, obviously, in the post-COVID environment. It will remain a key channel for discovering for trial of products, particularly for emerging markets and for emerging consumers. And the growth of travel retail in these days, for example, when travel is happening again, around the world is increasing, and not only in Asia, but particularly actually around the world. And this will continue. There is a very interesting channel, which is exclusive in the East, just starting in the West, which we consider a great opportunity for the future, which is the social selling and the social selling, which means the interaction between the social media activation and the selling. So you can go from Instagram to buy. You can go from TikTok Shop to TikTok social or vice versa. So this interaction between the social moment and the commerce moment, which is, by the way, ongoing in China, explosive growth. It's starting also in the West. And so you will see more of this driving the consumption because the immediacy from media moment and buying moment is obviously a big booster of buying. So that's why I hope I gave you an overview, a category, by channel, by geography, there are many, many reasons why this industry is expected to be a high-growth industry also for the next 10 years.

Incredibly detailed answer. One thing sort of elephant in the room that you didn't talk about, which was China. So we spoke about the emerging market ex-China and developed markets. When we can turn to your business in China specifically. And I guess my question is, between travel retail in China and the domestic Chinese market, Chinese consumers in totality have been a pretty integral part of the growth of your business over the past decade. Where are we today for this Chinese opportunity? And how is that intersection of travel retail for Chinese consumers versus the Mainland Chinese market? How is that channel interaction playing out today? And how is that interaction different maybe to what it looked like before the pandemic?

Yes, that's also very specific questions. And -- yes, let's start from the last part of your question. What was before the pandemic? Before the pandemic, I'm sure you know in the industry of -- in our industry, so in beauty -- in luxury beauty, there was 40% or 50% is estimated of the consumption or the purchasing act of Chinese consumer was happening outside of China during their travel. So this 40%, maybe 50% of consumption and purchasing that was happening outside of China during COVID obviously came back into China and came back into Mainland business going back into [ high-end ] business. So both in the traveling high-end situation and in Mainland situation. So it was a repatriation of a lot of consumption that was happening outside for our industry. That's obviously built the internal industry. Now we -- since the beginning of the story, we really follow Chinese consumers buying a -- Chinese consumer consumption rather than one where they buy, how they buy has been changing in the last 10 years, many times, been evolving. And by the way, it's very volatile also because the Chinese consumer is changing direction on where to buy easily, depending on pricing, depending on interest in the services they get provided, depending on the situation because buying is also a form of entertainment. And so traveling, for example, is -- buying during travel is very, very important for Chinese consumers or Chinese travelers. It's part of the joy of traveling, the joy of discovery. So in that sense, today, this is changing again. We see in this moment the traveling consumers around the world increasing. This is obviously the people that travel that go -- these Chinese consumers are traveling back to visit Paris or Tokyo and to be the high class, the high middle class, the high side of the middle class, they are, in this moment, less subject to the pressure in economy or the consumer sentiment issues that we see in Mainland China. So this consumer are buying. This part of business is growing. And when they travel, they buy sometimes in the Paris airport or in the London airport or they buy downtown in London at Harrods, at Selfridges, or they buy in Tokyo. Actually, Tokyo in this smoment is really booming in the sense, they buy in Tokyo mainly in the Tokyo department stores, for example, and they buy products which are interesting to them and maybe they look for novelty, they look sometimes for what they can buy at lower price. As you know, the yen is low in this moment. So it's actually a good, good moment to buy in Japan, so they buy a lot in sense, or they buy to discover new things that maybe are not available in their city, or their part. A lot of these travelers may come from Tier 4, Tier 5 cities, so they may not have stores, for example, of luxury in their city, they may have the access online, but not the access in brick-and-mortar. So it doesn't make -- the example of Japan because give you the tangible example what really happened. Departments stores in -- Japan has super high service department stores. So the pleasure of somebody living in a Tier 4 city where there is no brick-and-mortar experience can only buy online being in a Japanese department store to discover this brand in detail is a beautiful, pleasant experience. So they go for it. So that's why you see now a big growth of Chinese consumption in the various airports of the tourist's destination, a big growth in the downtown of touristy destinations. Then you look at the [indiscernible] they continue to be -- in our opinion, will continue to be an amazing center of consumption because there will be a lot of people continue to travel there. And this, over time, in the long term, will continue to grow and to continue to offer opportunity. In the last quarter, as we discussed during the last quarter, we saw growth in the retail in this area there is -- there's a lot of traffic increase at that time, although those are volatile, volatile time also in the traveling consumers within China, but this being growth. And then in Mainland, you have a phenomenal way in this moment, as you know, we have discussed in the last quarter as well. We see consumer sentiment being still soft. The market was declining overall internally. And so there is a soft market. We believe it's temporary. However, this is in this moment, the reality, and this is linked to consumer sentiment. Now it's true that the traveling consumers, which are growing clearly in all senses, as I explained, they tend to be high-end middle class while the Mainland consumers, they maybe buy -- the new middle class, they buy one time, they try to buy at the best possible price that's probably the people which are in this moment, more touched by the low consumer sentiment, by -- the softest. So there is a difference between middle class levels in which one is impacted more by the current situation, which, again, we believe this is going to evolve. But as we said in the last quarter discussion, when we look at the total, those are estimates because we don't -- we are not direct to consume everywhere in the world. So we need to estimate wholesalers things. But in these estimates, even in this soft moment overall in Mainland China, the total Chinese consumption is actually on a growing trend when you capture all of it around the world. So Chinese consumer remains a fundamental engine for growth for the long term. We are very well positioned in this Chinese consumer area. We have strong market shares. We have -- when we look at the market share by quarter, last quarter was a soft quarter. But when we look, for example, on the calendar year 2023, we have been growing market share in -- we've been growing market share makeup, we've been -- sorry, in fragrances that we are losing some market share, in makeup and this because we have not been playing yet aggressively enough in what is called the [ pure ] makeup, which is a big opportunity, which, by the way, Guillaume will comment in a second on, which is mainly a tenfold opportunity for us for the future, it will be a great opportunity for the long term. So net China is here to stay as a big engine of growth together with the emerging markets, together with the developed markets. And the moment -- the softness, the current softness linked to into consumer sentiment will improve. I think we are super well positioned to enjoy it also in Mainland China but definitely, we are already enjoying it in the come back to travel od the Chinese consumers, which is very exciting. Guillaume, maybe you want to add.

Listen, I'll echo some of what you said. I think it's even more relevant for the luxury segment in China for Tom Ford. So Tom Ford anchors the upper end of luxury in the portfolio of the Estee Lauder companies. Calendar '23 was a standout year for us last year for the market. Actually, the market grew double digits, both in fragrance and makeup. Tom Ford also grew double digits in both, and we outpaced the market both in fragrance and makeup. Actually, in makeup, we grew at twice the rate of the market in calendar '23 in the prestige market in the year. So in makeup, we see batch value remains important, particularly for items that are used in public. In fragrance, we see the collection effect that Fabrizio mentioned, where actually consumers are buying more than 1 fragrance and collecting. So we're seeing repurchase. That's important because this is a nascent category in China. There was not a lot of consumption of fragrance before. It was bought more to put on the vanity now it's purchased for use. And the actual customer lifetime value of fragrance is the highest. And so that's very important because we think that there is sustainability there. So we gained share in both of those categories, and we contributed in fragrance to the creation of the luxury and of the market in China. And that's what you refer, Fabrizio, often as the pyramid inverting. The pyramid being the upper end of fragrances, the luxury end of fragrances is becoming larger, and we're seeing that happen also in China. And so this phenomenon, which occurred during the pandemic is sustainable. If you compare actually post-pandemic the situation is that Tom Ford actually tripled the business in domestic China. So that's quite impressive. You also mentioned the other emerging markets -- in the other emerging markets, excluding China, Tom Ford doubled compared to pre-pandemic. So this is comparing to fiscal '19. That's the reference that we -- we look at. If you look at the categories compared to pre-pandemic, makeup doubled, and fragrance quite doubled during that period of time for Tom Ford in China. I think the brand is highly desirable also in China. That's really important. The media impact value of the brand in China ranks #7, is ranked by launch metrics and we're seeing a lot of loyalty with our consumers. When you look at channels, I think that both online and our own retail stores, along with, of course, the luxury department stores very important. Online is more for recruitment, and it's very important in second and third and fourth tier cities. We seeing such a fragrance -- of the recruitment sizes, the smaller sizes, there used to be a barrier to entry in fragrance. And now people starting to consume with the smaller sizes. Makeup is the same as recruitment format online. Whereas the other end of the spectrum in our retail stores, which is where we see the brand equity at its full -- within its full glory. We're seeing much higher penetration of high-net worth consumers as well as men -- are actually also present in the online channel for fragrance, 40% of our customer base. We're seeing a very high average natural -- average purchase in those retail stores. That is more than double what we see online. So that really reflects sort of what's happening with luxury in China overall. And we do see as the Chinese resume travel, we're seeing the same phenomenon that they're also -- we are gaining share in Greater China overall, including travel retail and the other neighboring countries during that same period of time.

Guillaume, maybe we can stick with you because [indiscernible] have you here. You've spoken a lot there about Tom Ford. But everyone in the room can see on the stage behind you, the rest of your title is luxury business development, and the Estee Lauder Companies is in the process of -- to recreate what you've done with Tom Ford, now with the BALMAIN brand going forward. So I guess my question is, what are the learnings that you think you can take from the success you've had with Tom Ford to the BALMAIN brand? And how do you balance the benefits of building these luxury brands from scratch within the beauty versus the drawbacks, the trade-offs in terms of the time it takes to build.

Yes. Listen, I think that -- yes, we'll be launching BALMAIN in September 2024. We signed a partnership with BALMAIN about 2 years ago. So we're on track to launch in time in September with the fragrance in the beginning. And I think that we are taking a lot of good learnings for -- from Tom Ford for this development. And I think it starts with an incredible equity of the brand or the founder so -- BALMAIN fashion has been around since 1945. They have very strong codes, they have also -- which was the same for Tom Ford [indiscernible] already, a fully developed one, very strong vision from the creative director, which we work very closely with and influences the creativity. Of course, we uphold the highest levels of quality as well in the product that we developed. We create innovation that is unparalleled in terms of the uniqueness of the conceptual innovation that we create that has to deliver more than -- on tangible attributes also on creating concepts that don't exist yet in the market. And so I think the -- if you look at some of the -- Tom Ford really has been a phenomenon for us in terms of delivering sustainable growth. And so you ask what are the drawbacks of -- in terms of speed, I think that you know Tom Ford is a top 20 brand overall in the past -- under 10 years, it gained 30 rank. It was 50, it's now 30. You look at fragrance, it's a top 10 brand in fragrance under 10 years in at [ 18 rank ]. Makeup is also top 20, and gained 20 ranks in makeup in under 10 years. The fragrance market -- fragrance business account for double since pre-pandemic. So I think there's a number of elements here in the growth and the ranking progression of the brand that shows that luxury has staying power and that it has steadily delivered ranking progression and growth that is sustainable and profitable. And so that is the reason why -- those are some of the elements that are replicable from what we've done both equity-wise as well as financially and commercially from Tom Ford that are replicable to BALMAIN and that is unique in the way of working at the Estee Lauder Companies, which Fabrizio often comments on connecting creativity and analytics. This is the best example of that is like it leverages both the strategic way of managing brands on the Estee Lauder Companies with the equities of another party that brings that creativity together. And I think the connection between the 2 is where is the genius of the company.

Okay. I like that. Let's go back to Fabrizio. So to my first question, you started...

By the way, I've been humbled, but the BALMAIN is really beautiful. The execution they're making with the support, the BALMAIN team and the creative [ director ] is outstanding. So I'm sure in September, you will have a very important reaction to what you will see what kind of luxury brand can we create.

I agree, I think brand creation -- and thank you for that opportunity, a rare occasion. And I think to do so with Olivier Rousteing, who the designer of BALMAIN, is both the youngest and the most tenured of any designer in [indiscernible] fashion house -- it's extremely inspiring to work with him. And I think that the mandate was to create something that was unique and breathtaking. And I think we'll hopefully fulfill that dream when we reveal the brand in the fall.