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The Estée Lauder Companies Inc. (EL) Q3 2023 Earnings Call Transcript

The Estée Lauder Companies Inc. (EL)

Q3 2023 Earnings Conference Call

Company Participants

Rainey Mancini - Senior Vice President of Investor Relations

Fabrizio Freda - President, and Chief Executive Officer

Tracey Travis - Executive Vice President, and Chief Financial Officer

Conference Call Participants

Dara Mohsenian - Morgan Stanley

Chris Carey - Wells Fargo

Rupesh Parikh - Oppenheimer

Oliver Chen - TD Cowen

Lauren Lieberman - Barclays

Presentation

Operator

Good day, everyone, and welcome to The Estée Lauder Companies' Fiscal 2023 Third Quarter Conference Call. Today's call is being recorded and webcast.

For opening remarks and introductions, I would like to turn the call over to Senior Vice President of Investor Relations, Ms. Rainey Mancini. Ma'am, you may begin.

Rainey Mancini

Hello. On today's call are Fabrizio Freda, President and Chief Executive Officer; and Tracey Travis, Executive Vice President and Chief Financial Officer.

Since many of our remarks today contain forward-looking statements, let me refer you to our press release and our reports filed with the SEC, where you'll find factors that could cause actual results to differ materially from these forward-looking statements.

To facilitate the discussion of our underlying business, the commentary on our financial results and expectations is before restructuring and other charges and adjustments disclosed in our press release. Unless otherwise stated, all organic net sales growth also excludes the non-comparable impacts of acquisitions, divestitures, brand closures, and the impact of foreign currency translation. You can find reconciliations between GAAP and non-GAAP measures in our press release and on the Investors section of our Web site.

As a reminder, references to online sales include sales we make directly to our consumers through our brand.com sites and through third-party platforms. It also includes estimated sales of our products through our retailers' Web sites.

During the Q&A session, we ask that you please limit yourselves to one question, so we can respond to all of you within the time scheduled for this call.

And now I'll turn the call over to Fabrizio.

Fabrizio Freda

Thank you, Rainey, and hello to everyone. We appreciate you being with us today to discuss our third quarter results, and revised outlook for fiscal year 2023.

In the third quarter, organic sales fell 8% at the high-end of our outlook range, and the sequential improvements from the decline of 11% in the second quarter. Nearly all developed and emerging markets grew organically, and outperformed our expectations to offset an even lower-than-expected recovery in our Asia travel retail business.

As we discussed in February, Asia travel retail faced two headwinds in the third quarter. The first, elevated inventory in Hainan, given retailers 'expectation for a more accelerated recovery proved very challenging, as conversion of travelers to consumers in prestige beauty lagged historical trends, as travels initially gravitated through other categories. This led to even lower replenishment orders than we anticipated.

The second headwinds, the transition in Korea to post-pandemic regulations as traveling consumers gradually returned pressured sales meaningfully. In China and Korea, the resumption of international flight was subdued. Limited visas were granted, and group tours were slow to restart. These factors resulted in lower-than-expected traffic in airports throughout the region, which combined with a lower-than-expected conversion further moderated replenishment orders.

With this said, there were bright spots for travel retail in Hong Kong, Macau, Europe, and the Americas. All told, global travel retail organic sales declined 45%. This was partially offset by excellent organic sales growth of 10% in the rest of our global business. Our retail sales growth was even stronger than organic sales growth in many markets around the world, including China and the U.S. Encouragingly, retail sales performance is significantly ahead of organic sales result in global travel retail, which gives us confidence that the challenges in travel retail are abating with time.

Furthermore, this strength at retail, including prestige beauty share gains in many markets demonstrated a benefit of our continuing investment in innovation and building the desirability of our brand around the world. This positive retail trends are expected to continue in the fourth quarter.

Adjusted diluted EPS in the fiscal third quarter fell 75%, which was also at the high-end of our outlook. We invested to fuel market in various stages of post pandemic recovery, launching sought after innovation, expanding brand into markets, and increasing advertising as percentage of sales. As the shape recovery for Asia travel retail comes into better focus, it is proving to be both far more volatile than we expected, and more gradual relative to what we experienced in other markets. We are therefore lowering our organic sales and EPS outlook for fiscal year 2023, as we reduced our implied fourth quarter outlook, primarily for Asia travel retail.

For Asia travel retail, there are two factors driving our revised outlook. In Hainan, the pressure from elevated inventory in the trade is proving to be deeper and longer-lasting, driven by this lower-than-expected consumption trend I discussed compounded by the retailer inventory tightening. Second, the resumption of international travel by Chinese consumer is evolving more slowly than we anticipated.

Having visited Shanghai and Hainan in March, and witnessed firsthand the optimism of consumers, retailers, [fashionists] (ph), and our local teams, I am very encouraged for the future of our business with the Chinese consumers. I also had the good fortune to officially open our new China Innovation Lab, and met with the amazing scientist and product development specialist in the state-of-art R&D facility which further bolstered my confidence in the business fundamentals. Indeed, the opportunity for prestige beauty and our brands with the Chinese consumer in the mid- to-long term remains vibrant in the domestic market, in Hainan and internationally, which remains our focus through this complex phase of recovery from the pandemic.

For our fourth quarter outlook, the far slower organic sales growth that we anticipated in February is impacting profitability significantly. There are two factors at play be under pressure to a bigger margin accretive area of our business. First, with the rest of the business growing strongly, we will continue to invest to drive the momentum in those areas.

Second, strategic and necessary long-term investments in manufacturing, R&D, and information technology capabilities are pressuring margin with the slow recovery of sales. With this said, we are obviously not satisfied by the profitability in our revised outlook for fiscal year 2023. For the future, we are focused on a plan to further accelerate our growth in key markets, return to organic sales growth in our Asia travel retail business, and skincare category, and to progressively rebuild margin across brands, categories, and regions.

Let me now share more about our third quarter performance as numerous growth engines excelled. Looking at regions, each of the Americas and Asia-Pacific returned to organic sales growth, which complemented ongoing gains in the domestic markets of EMEA. Developed markets from every regions contributed, lead by the United States, U.K., and Hong Kong. While organic sales in our emerging markets grows an outstanding 17% globally. Impressively, in the domestic markets of EMEA we realized broad-based trends as every category grew double-digits organically. The breadth of growth engines by category was matched by the breadth of growth engines by channel, lead by specialty-multi and online [indiscernible], driven by the successful go-to-market strategy as we focus on high potential channels.

In Western Europe, our brands successfully engaged with consumers to generate trial and repeat. The examples are many; Estée Lauder, Bobbi Brown, and Too Faced driving vital success on TikTok, to M·A·C, leveraging Paris Fashion Week for its M·A·C Locked Kiss Ink lipstick launch, and La Mer hosting dermatologists for a unique event. This collective initiatives featuring enticing innovation in hero brands drove the company accelerating prestige beauty share gains for the quarter in Western Europe.

Looking at Asia-Pacific, it similarly delivered diversified growth in nearly every market, and each category contributed to the regions return to organic sales growth. Fragrance was a standout, rising double-digit, fueled by excellent performance of our luxury and our seasonal portfolio, lead by Jo Malone London, Le Labo, and TOM FORD Beauty. These brands hero franchises welcome new consumers into the category, while locally inspire innovation and enriching in-store services further contributed to the expansion of this promising category in the region.

Mainland China grew low single-digits organically, after four quarters of pressure from COVID-19 restrictions and outbreaks. The beginning of the quarter was impacted by the lingering effect of the COVID cases in November/December. In January, retailers were to existing inventory, extracting gradually returned, such that organic sales declined steep double-digits. As the reopening progressed, organic sales grows double-digit in each of February and March.

Even in this complex quarter in Mainland China, consumer desire for high-quality products elevated experience as newness was clear, and our brands delivered, lead by Estée Lauder and La Mer. For Estée Lauder, skincare fueled its growth. Consumer gravitated to the brands innovation, and cheered across franchises, most especially its luxury-oriented ReNutriv, as well as Supreme. La Mer further contributed, boosted by its beauty advisor offering, differentiated services, and the launch of reformulated moisturizing soft cream, which attracted new consumer with its advanced benefits. Encouragingly for the third quarter, our prestige beauty share gains in Mainland China accelerated sequentially, driven by skincare as well as both online and brick-and-mortar....

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