Estée Lauder Companies Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 3, 2023

There are 8 speakers on the call.

Operator

Good day, everyone, and welcome to The Estee Lauder Companies Fiscal 2023 Third Quarter Conference Call. Today's call is being recorded and webcast. For opening remarks and introductions, I'd like to turn the call over to Senior Vice President of Investor Relations, Ms. Rainey Mancini. Ma'am, you may begin.

Speaker 1

Hello. On today's call are Fabrizio Freda, President and Chief Executive Officer and Tracy 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.

Speaker 1

You can find reconciliations between GAAP and non GAAP measures in our press release and on the Investors section of our website. As a reminder, references to online sales include sales that we make directly to our consumers through our brand.com sites and through 3rd party platforms. It also includes estimated sales of our products through our retailers' websites. During the Q and A session, we ask that you please limit yourself 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.

Speaker 2

Thank you, Rainey, and hello to everyone. We appreciate you being with us today to discuss our quarter results and revised outlook for fiscal year 2023. In the Q3, organic sales fell 8% at the high end of our outlook range and the sequential improvements from the decline of 11% in the to offset an even slower than expected recovery in our Asia Travel Retail business. As we discussed in February, Asia Travel Retail faced 2 headwinds in the 3rd 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 to other categories.

Speaker 2

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 return pressured sales meaningfully. In China and Korea, the resumption of international flights was subdued. Limited visa 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.

Speaker 2

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 Encouragingly, retail sales performance is significantly ahead of organic sales results 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 the benefits of our continued investment in innovation and building the desirability of our brands around the world.

Speaker 2

These positive retail trends are expected to continue in the 4th quarter. Adjusted diluted EPS in the fiscal 3rd quarter fell 75%, which was also at the high end of our outlook. We invested to fuel markets in various stage of post pandemic recovery, launching sought after innovation, expanding brands into new markets and increasing advertising as a percentage of sales. As the shape of recovery for Asia travel retail comes into a 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 reduce our implied 4th quarter outlook, primarily for Asia Travel Retail.

Speaker 2

For Asia Travel Retail, there are two factors driving our revised outlook. In Heinem, 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. 2nd, the resumption of international travel by Chinese consumers is evolving more slowly than we anticipated. Having visited Shanghai and Hainan in March and witnessed firsthand the optimist of consumers, retailers, partners and our local teams, I'm 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 scientists and product development specialist in the state of art R and D facility, which further bolsters my confidence in the business fundamentals.

Speaker 2

Indeed, the opportunity for prestige beauty and our brands with the Chinese consumer in the medium 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 Q4 outlook, the far slower organic sales growth that we anticipated in February is impacting profitability significantly. There are 2 factors at play beyond the pressure to a big margin accretive area of our business. 1st, with the rest of the business growing strongly, we will continue to invest to drive the momentum in those areas. 2nd, strategic and necessary long term investments in manufacturing, R and D and information technology capabilities a pressure in margin with a slower recovery of sales.

Speaker 2

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 skin care category and to progressively rebuild margin across brands, categories and regions. Let me now share more about our Q3 performance as numerous growth engines excel. 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 region contributed, led by the United States, the U.

Speaker 2

K, and Hong Kong, while organic sales in our emerging markets rose 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, led by specialty multi and online pure player retailers driven by the successful go to market strategy as we focus on high potential channels. In Western Europe, our brand successfully engaged with consumers to generate trial and repeat. The examples are many.

Speaker 2

MAC Lochte's ink lipstick launch and La Mer hosting dermatologists for a unique event. These collective initiatives featuring enticing innovation and hero products drove the company accelerating prestige share gains for the quarter in Western Europe. Looking at Asia Pacific, it similarly delivered diversified growth. Nearly every market and each category contributed to the region's return to organic sales growth. Fragrance was a standout, Rising double digit, fueled by excellent performance of our luxury and artisanal portfolio led by Jo Malone London, Lilibot and Tom Ford Beauty.

Speaker 2

These brands' hero franchises welcome new consumers into the category, while locally inspired 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 such that organic sales declined steep double digits. As of the reopening progressed, organic sales rose double digits in each of February March. Even in this complex quarter in mainland China, consumer desire for high quality products, elevated experiences and newness was clear and our brands delivered led by Estee Lauder and La Mer. La Mer further contributed boosted by its expert beauty advisor offering differentiated services and the launch of the reformulated moisturizing soft cream, which attracted new consumer with its advanced benefits.

Speaker 2

Encouragingly, for the Q3, our prestige beauty share gains in Mainland China accelerated sequentially, driven by skincare as well as both online and brick and mortar. In the Americas, the United States returned to organic sales growth, invigorated by strategic go to market initiatives and innovation to engage existing as well as new consumers. The ordinary soared, owing to its heroes and the winning streak of innovation with the latest being multi peptide eye serum, which is bringing in the new consumer demographic. Estee Lauder introduction of the revamped Nutritious franchise focused on JetZ with all new skincare products and launched exclusively with Ulta Beauty, realized strong initial uptake. Looking at makeup in the United States, MAC, Clinique and 2 Phase fueled excellent performance with targeted initiative to serve various consumer demographics across freestanding stores, specialty multi and department stores.

Speaker 2

For Clinique, it is a case study in successfully leveraging viral success of a product. In its case, almost lipstick in Black Honey to drive organic sales growth in many subcategories. Across regions, emerging markets showed The double digit organic sales growth in emerging markets this quarter extends our fiscal year to date momentum with strong contribution from India and Brazil. Globally, our diverse portfolio brands served as a powerful catalyst for growth. MAC, Tom Ford Beauty, The Ordinary and L'Eau both each contributed strong organic sales growth and demonstrated the gains to be had across our large scaling and developing brands.

Speaker 2

M. A. C. With its global reach as per the artistry as service oriented freestanding stores continue to realize The brand leveraged its market leading EMV ranking with high impact activation and product launches in makeup. Consumers also embrace MAC new Hyperreal franchise in skincare, which should represent an incremental growth engine for the brand over time.

Speaker 2

Importantly, Hyperreal is another example in our portfolio of exciting East to West innovation as it was born in Asia Pacific and launched globally. Tom Ford Beauty delivered double digit organic sales growth, excelling across fragrance and makeup. In fragrance, the new private blend Cherry Collection was an instant hit, while the brand's extension of Tom Ford Noir Stream, Eau de Parfums into Parfums captivated consumers seeking intensity and the highest quality. We are thrilled to have enriched our brand portfolio last week The deal is a wonderful outcome of our successful journey with the brand, which began when we collaborated to create Tom Ford Beauty over 15 years ago. The ordinary ingredient focused product prospered in its heritage markets as well as in new markets evidenced by the brand's very successfully February launch in the Middle East, while L'EraBeau continued to evolve from strength to strength fiscal year 2023 to reflect the deeper pressure in Asia travel retail given its standard recovery and related retail inventory tightening, we are encouraged by the strong momentum in the rest of our business.

Speaker 2

Looking ahead, we are focused on a strong acceleration of balanced organic sales growth across regions, categories and channels and progressively rebuilding margin. Indeed, consumer demand is for our diverse portfolio brands in developed and emerging markets globally, evidenced in both organic sales growth and retail sales trends. This drives our confidence in the future. To our employees, I extend my deepest gratitude for your exceptional to exceed consumer desires around the world with our beautiful portfolio of brands. I will now turn the call over to Tracy.

Speaker 3

Thank you, Fabrizio, and hello, everyone. Our 3rd quarter organic net sales declined 8% and earnings share decreased 75% to $0.47 As Fabrizio mentioned, despite continued challenges in our Asia travel retail business, we experienced accelerated growth across our markets globally with nearly every market expanding as they progress through various stages of recovery from the pandemic. From a geographic standpoint, organic net sales in our Asia Pacific region rose 7% with nearly all markets contributing led by Hong Kong, which doubled in size partially due to the return of Chinese travelers, while Australia grew nearly 50% and Japan rose double digits. Mainland China also returned to growth this quarter showing positive signs of recovery in February March after the pressure from the increase in COVID cases and slower retail traffic in January. Throughout the region, markets continued to progress and recovery with fewer COVID restrictions compared to last year, leading to growth in all product categories with the return of brick and mortar traffic.

Speaker 3

Strong double digit growth from the region's emerging markets contributed one point to Asia Pacific's growth. Organic net sales in the Americas rose 6%, led by the United States. In North America, organic net sales grew mid single digits, reflecting growth in skincare, makeup and fragrance. The ordinary, MAC and Laliboe excelled, each rising double digits in the quarter. Specialty multi growth, including distribution expansion, drove the increase in brick and mortar along with contributions from freestanding stores and department stores.

Speaker 3

In Latin America, organic net sales grew double digits, benefiting from growth in every country and in all product categories with particular strength in makeup and fragrance. Organic net sales in our Europe, the Middle East and Africa region fell 24%, driven entirely by the travel retail business. Our global travel retail sales continue to be pressured by our Asia travel retail business, which Fabrizio described. Outside of Asia, we experienced double digit sales growth in Travel Retail as international travel increased throughout Europe in the Americas. The overall performance in Travel Retail more than offset the organic net sales growth from the rest of the EMEA region, where we drove strong performance in all product categories and from nearly all channels of distribution.

Speaker 3

Organic net sales rose across both developed and Emerging Markets led by the United Kingdom, Germany, France, Italy and Turkey as the progression to recovery continued and tourism resumed. From a category standpoint, Fragrance continued its momentum as organic net sales rose 14%. Strong demand for our products and high touch services as well as innovation fueled growth across every geographic region. Tom Ford Beauty, LALABO and Estee Lauder each grew double digits in the quarter. Organic net sales in hair care grew 3% and sales were virtually flat in makeup.

Speaker 3

Makeup growth in the Americas, Asia Pacific and the markets in EMEA, excluding travel retail, was offset by the pressures in Asia travel retail. MAC and Clinique continued to drive makeup recovery and double digit growth from Tom Ford Beauty and Too Faced also contributed. Nearly every market in Asia Pacific realized strong growth in the category, partially offset by softness in Mainland China. Organic net sales in skin care fell 17% due to the pressures affecting Asia Travel Retail. The declines from La Mer and Estee Lauder were partially offset by standout performance from the ordinary and MAC.

Speaker 3

The ordinary benefited from strong growth in specialty multichannels, particularly in the U. S. As well as from geographic expansion into India expanded its offerings in the category and contributed to growth. Our gross margin declined 7.50 basis points compared to last year, largely due to the slower than expected recovery in Asia travel retail. This includes obsolescence charges, higher promotional costs and gift sets to drive increased consumption, excess overhead absorption in our plants due to the pull down of production throughout the year given higher inventory levels and less favorable brand and category mix.

Speaker 3

Operating expenses increased compared to last year. Operating income declined 66 percent to $316,000,000 and our operating margin contracted 13 20 basis points to 8.4% in the quarter. Despite the volatility that has significantly impacted net sales, we have sustained certain of our strategic investments to support recovery in select markets and the strengthening of our multiple engines of growth. We've continued to invest in areas imperative to long term profitable growth, including innovation, advertising, the growth of our emerging markets, the geographic expansion of some of our brands, production capacity and consumer engagement. Our effective tax rate for the quarter was 43.1% compared to 21.3% last year.

Speaker 3

The increase in rate was primarily due to the expected further and earnings related to our travel retail business for fiscal 2023. Diluted EPS of $0.47 decreased 75% compared to last year. This was at the high end of our outlook despite the significantly higher than normal tax rate. The impact from foreign currency translation and foreign currency transactions in key travel retail locations negatively impacted diluted EPS by 1% and 3%, respectively. For the 9 months, we generated $1,000,000,000 in net cash flows from operating activities compared to $2,000,000,000 last year.

Speaker 3

The decline from last year reflects lower net income, partially offset by lower working capital. We invested $652,000,000 in capital expenditures, and we returned $945,000,000 in cash to stockholders through both dividends and share repurchases. On April 28, we were pleased to complete the acquisition of the Tom Ford brand. The amounts paid at closing of approximately $2,250,000,000 were funded through a combination of cash, including the proceeds from the issuance of commercial paper $250,000,000 received from one of the licensees of the brand, Markelon. An additional aggregate amount of $300,000,000 in deferred payments at 5% interest per annum to the sellers becomes due from the company beginning in July 2025.

Speaker 3

We estimate an EPS dilution to the full year of approximately $0.03 to $0.04 And now turning to our outlook for fiscal 2023. Clearly, this fiscal year has proven to be a perfect storm of higher than anticipated volatility from both global external headwinds and uncertainty surrounding the timing and pace of recovery from the COVID-nineteen pandemic, primarily in China and Asia travel retail. In August, we expected a gradual improvement throughout the first half of the fiscal year as markets and international travel began to recover from the impacts of COVID restrictions. However, The actual impacts to our business in Asia Travel Retail and China, to a lesser extent, have been far greater than we anticipated given challenges from the pandemic, including a slower than expected recovery of traffic and sales conversion in prestige beauty in these markets. Further compounding this pressure is the tightening of inventory by retailers in Hainan.

Speaker 3

We now expect that a far more gradual return to normal sales growth in Asia Travel Retail is likely to persist into the first half of fiscal twenty twenty four. In addition, higher inflation and currency volatility as well as promotions in certain markets to alleviate high stock levels more than offset our price increases further pressured our business margins. In spite of the volatility in Asia Travel Retail that delayed the recovery relative to what we had expected, as well as the macro pressures from inflation and currency, we have been encouraged by the faster than anticipated improvements across many of our markets globally as they progressed through various stages of recovery from the pandemic. While we are lowering our full year outlook we plan to invest in markets where traffic and consumption are returning and expect to return to overall net sales growth in the 4th quarter. This reflects double digit sales growth in the Asia Pacific region, including Mainland China as well as in EMEA, excluding Asia Travel Retail.

Speaker 3

The Americas is planned to grow single digit. Currency also continues to pressure margins relative to prior year. As Fabrizio mentioned, we are certainly not satisfied with our results this fiscal year and will address plans to progressively rebuild the margin accretive areas of our business beyond this fiscal year from the current year's level. When full recovery does occur from the pandemic, we do expect the return to healthy growth of our Asia travel retail business and in our related skincare category supported by a more normalized level of investment in selling, advertising and promotional activities, reflective of the increased brick and mortar traffic. With these assumptions as our backdrop and using March 31 spot rates of 1.09 for the euro, 1.239 for the pound, 6.872 for the Chinese won and $12.97 for the Korean won, we now forecast organic net sales for the full year to decline 7% to 5%.

Speaker 3

Currency translation is expected to dilute reported sales growth for the full fiscal year by 4 percentage points, and we anticipate an additional one point of dilution from the impact of certain foreign currency transactions in key international travel retail locations. The impact of sales from certain designer license exits are expected to dilute reported growth by approximately 1 point. Full year operating margin is forecasted to be approximately 11.1 percent, an 8 60 basis point contraction from the prior year period, primarily due to the disruptions from COVID restrictions that not only impacted sales in Asia travel retail and Mainland China, but also resulted in increased obsolescence charges, discounts and promotional expenses. Foreign currency impacts and the strategic investments I mentioned previously are also expected to pressure margin. We now expect our full year effective tax rate to approximately 27%, reflecting the change in our estimated geographical mix of earnings for the balance of the year.

Speaker 3

Diluted EPS is expected to range between $3.29 $3.39 before restructuring and other charges and includes the expected impact of the Tom Ford acquisition I mentioned previously. This includes approximately $0.26 of dilution from currency translation. In constant currency, we expect EPS to decline approximately 51%, which includes a negative impact from foreign currency transactions in key international travel retail locations of approximately 4 percentage points. While this has been a challenging and disappointing year, navigating through many uncertainties, the strength we are seeing in many of our recovery markets gives us tremendous optimism for the future. Our long term fundamentals and strategy remain intact as does our confidence in the long term growth opportunities for Global Prestige Beauty and our brands with the investments we've made to sustain long term profitable growth.

Speaker 3

On behalf of Fabrizio and The Estee Lauder Company's leadership team, we want to extend our immense gratitude to all of our employees around the world. We recognize that this has been an incredibly challenging year for you, and we want to thank you for your extraordinary efforts, your dedication and commitment to the company and your resilience as we continue together on our path to recovery. And that concludes our prepared remarks. We'll be happy to take your questions at this time.

Operator

We will limit each person to one question. Time permitting, we will return to you for additional questions. And the digit 1. Our first question today comes from Dara Mohsenian from Morgan Stanley. Please go ahead with question.

Speaker 4

Hey, good morning guys. So I just wanted to touch on the three areas of weakness versus prior guidance in China, taking a step back, the magnitude of changes to your guidance stemming from the areas is obviously severe And it also looks more onerous than peers. So just as you take a step back and look at the weakness versus what was expected, How much of that is do you think more just the timing of recovery in beauty at the consumer level coming out of COVID Or retailer inventory issues, which in theory are more shorter term versus the potential for the longer term recovery in the beauty category Is lower in these areas. So really just perspective on lower long term sales potential versus more short term issues. And I know it's hard to speak relative to peer results and guidance, but it does look like the issues are more severe for Estee versus peers.

Speaker 4

So just any perspective on Estee's market share company performance in these areas would also be helpful? Thanks.

Speaker 3

Okay. Dara, so thank you for the question. In Hainan, as we said in the prepared remarks, we are starting to see during the quarter passenger traffic come back in Hainan and that's been very positive. As Fabrizio mentioned in his prepared remarks, we had a group was in Hainan a few weeks back and saw quite a bit of activity. So we are very encouraged.

Speaker 3

And in fact, Hainan actually reflected positive retail sales in the 3rd quarter. So this is The Q1, the high end performance for us has been up and down all year, and some of the swings have been quite severe, but we did see a progression to positive retail sales. I think the thing that gives us more comfort now on a more continuous steady progression of recovery is the fact that the COVID restrictions have been lifted. And so what we were experiencing before with our travel retail business is the volatility related to some of the COVID restrictions and the flow of traffic and travel and people's comfort with travel. So that gives us more comfort that we're going to see a recovery.

Speaker 3

When in terms of our at the beginning of this year. We had very strong momentum in coming into the year in travel retail, in Hainan in particular, our July results were up strong double digit, then Hainan went into closure, and that extended for longer than we had anticipated. But given the results we had seen in July and actually in some previous months, we had expected that that recovery would happen faster once the lock was lifted and that didn't happen. And so we ended up with and our retailers also expected that recovery. We ended up with more inventory in the trade than what was needed basically for the level of sales that were being done in Hainan.

Speaker 3

So our pullback in inventory right now given the pace of recovery that we're seeing, again, we're encouraged, but the retail inventory needs to come down and therefore we are pulling back on our shipments. Korea, we talked about in the last call in terms of what happened in Korea. We basically have a change in the rollback of COVID-nineteen related supportive measures with Korean duty free operators and that too was pretty in the Q3, the expectation is that we will see travelers come back to Korea and come back to duty free shopping in Korea. But that has not happened yet. Korea benefits from having a lot of organized tour business from Chinese traveling consumers, and that has been slower to come back.

Speaker 3

So that certainly is pressuring our 4th quarter as well. And again, it's been difficult to predict the timing of all of this recovery, but we do know the recovery is happening. So We don't believe there is an issue at all with prestige beauty. When we look at the recovery we're seeing in the Americas, in other Asia Pac regions, in EMEA, we see very strong recovery of prestige beauty and actually are seeing an acceleration of fragrance, makeup and skin care. So it really is based on what we're seeing in other regions given they are further along in the recovery relative to some of the regions that you asked about.

Speaker 2

And that I just want to add that so as Tracey explained in TR is really an issue of inventories versus pace of recovery. And not approval that is that our retail in travel retails is so much stronger than our net. So you had a minus 45 in quarter 3 versus a single digit decline in retail. There is a lot of inventory absorption, which is going on with the recovery. And a lot of the speed of these absorption will depend on the speed of the recovery that we have in front of us.

Speaker 2

We are estimating that given the trend in this period in the quarter 4, retail will go positive and then the absorption will continue to improve over time and definitely continue in quarter 1 of next year, next fiscal year. On other encouraging point, I want to touch briefly on China that you asked Also about. So in China, we returned to organic growth, which is excellent news. And we expect a double digit growth in quarter 4 And I want to underline that when we the problem with the volatility in China started in the period where Shanghai got closed And we were particularly affected by the closure of Shanghai. At that moment, during these 3 months of closure, we lost Significant market share.

Speaker 2

Now the good news, we are now essentially made up for the lost market share from the lockdowns, we are back in line with the total market share and we expect in quarter 4 because also of the low base to get into a positive market share growth versus also the pre lockdown period, which is extraordinary. We said that we would have tried to Cover this in 1 year and we will do that and better than that. The other important thing to underline that Linked to this TR issue, there is the skincare issue obviously, because there is a high percentage of skincare, which is a very profitable category for us. And I want to also underline that skincare is growing. XTR Skincare is growing globally plus 6%.

Speaker 2

So we are growing skincare. We will grow skincare. We are growing skincare in China Mainland. Air Retail is growing ahead of the market that we are building market share in quarter 3 and we expect to do even more in quarter 4. And Estee Lauder La Mera driving this growth with La Mer growing double digit at retail in the quarter in China and lower single digit.

Speaker 2

So the last part of your question is our different situation versus peers, I would say that if you look at the business overall, the answer of the difference is in the level of stocks in the TR and the volatility and the fact that we are bigger in the historically more exposed to this strong accretive channel that in a moment of crisis obviously resulted into a bigger negative.

Operator

And our next question comes from Chris Carey from Wells Fargo. Please go ahead with your question.

Speaker 5

Hi, good morning everyone.

Speaker 3

Good morning.

Operator

I guess,

Speaker 5

just digesting these results and taking Tara's question in consideration. I guess it's like APAC and Americas actually exceeded expectations, which in a way probably helps combat this dynamic of it's category or brand or structural issue. I think it's also probably not fully understood that L'Oreal and others have several years and obviously that created a lot of great tailwinds during the up move, but it's just created an enormous amount of volatility. And I think also a lack of visibility as we've come into this kind of downtrend, right? And I hear you on rebuilding demand building activities and leaning into the market, But I just wonder, does this market need to reset lower before you can really talk about stabilization?

Speaker 5

Or are we really just we had one more quarter or 2 of issues and we're really rebuilding from there, right? And I appreciate Korea and China all have Dynamics, but I think the overall context here is certainly that the travel retail business is creating a ton of volatility for your business. And then just related to that, and I apologize, but the fiscal Q4 guidance range is quite wide and I think that maybe speaks visibility, can you maybe just talk about how you might be approaching the concept of guidance given the lack of visibility so that perhaps we can maybe avoid some of these resets. So thank you so much for any of that perspective. Very much appreciated.

Speaker 2

Okay. Let me start. Thank you for the question. And Our point of view is that, as you said, this is kind of a reset. But then after this reset, Travel retail will remain a large, a very important channel, because it's an important channel also for consumer acquisition and is a growing channel.

Speaker 2

And so to grow global market share to be strong in travel retail will remain important. Also in the case of Asia travel retail and China travel retail is very important for coverage because in many, many Emerging markets for sure in China, the coverage of small cities is possible only via online and via the people traveling Because the brick and mortars are not there, are only in a part of the city, which is the reason of high productivity in China. So travel retail is also a great opportunity for discovering product, for the physical experience, for interacting with our product. So and is a very luxury channel, meaning the experience of luxury is very high. So the issue with travel retail has been really that during a pandemic, The volatility of travel and the interest and the possibility of travel is so much impacted by regulation change, the pandemic up and downs, etcetera.

Speaker 2

Obviously, in a moment of a pandemic moment, travel retail has been more difficult to predict and has been more volatile to anticipate. But in term of the positives and positive profitable channel in the long term remains intact. And so We believe that out of the pandemic, this will remain important channel. Now will this be more balanced the growth? Absolutely.

Speaker 2

We have a plan and an interest in balancing our growth and balancing the proportion in all our business segments and we will continue to do that. The other thing I want to underline that the High inventories, Trish explained what was the sequence of event and the reason why our retailers and us went for higher inventories at the beginning of the fiscal year and then we encountered that with this issue of the slower recovery than anticipated. And Remember the important thing and in this lower recovery also the retailers want less stock and so the replenishment get affected as Tracy has planned. So in this situation is also impacted by our relatively long supply chain, where you need to order and then after months you receive it, the relatively long supply chain as an impact on the fact that the retailers when they decide their stock for us, which is not true for every one of our peers, They need to make a bet several months before when they receive the products. And that issue, obviously, in the middle of the worst volatility we have has been difficult for our retailers and for us to estimate with such an anticipation.

Speaker 2

So we are acting on this. All the investments we have done, which in part are visible in our short term profitability pressure, like the manufacturing that we call Sakura in Japan that will have the new distribution center in Mainland China and in the near future in Aynan, Exadata all designed these investments to shorten the lead time. Now the shortening of the lead time would also reduce the risk of being wrong in the choices in volatile moments. And so assuming that a certain amount of volatility will The other thing is, let's not under evaluate the investment in the R and D center in Shanghai that will reduce that will increase the speed of innovation, reduce the timelines of innovation as well and will have another impact of better ability to make the right decision even volatility because faster reactivity. In other words, we have built agility and agility is one of the things that will make our future ability to forecast TR in the correct way.

Speaker 2

So in summary, we count on continue having a strong TR business in the future. There is a reset that our retailers and the market are doing for us, but is But after that, we will continue grow but we will continue to grow in a more balanced way and with better agility to make the right

Speaker 3

forecasting. So as Fabrizio said, we have made some structural changes to the business that going forward should allow us to manage volatility. Hopefully, we won't see the level of volatility that we've seen certainly over the past year, but we will have more agility in our operations. To your question on the Q4 and what's in our implied guidance, as it relates to travel retail. Coming off of the trends that we're seeing in March, and our net sales are down double digit, down double digit more than our retails are up.

Speaker 3

So again, this is another quarter of trying to whittle down the inventory that's in the trade, hence the impact that you see in the Q4. And as Fabrizio said, much of that being our very strong skincare business. So we do expect, as I said in my prepared remarks, that some of this will bleed into the Q1 and perhaps a little bit into the Q2, but get progressively better until we get to the inventory levels that both we and our customers want in the trade. We are working with and partnering with our customers on programs. Also now that traffic is back in airports, we are investing in advertising in airports.

Speaker 3

We are reemploying some of the sales staff that was not there when the airports were empty. And we are working with our brands on great programs and promotions for customers as they return to airports. So our travel retail team has been quite busy working with our retailers to recapture the growth that we're now seeing in particular In Hainan and hopefully soon in Korea as well.

Operator

Our next question comes from Rupesh Crick from Oppenheimer. Please go ahead with your question.

Speaker 6

Good morning and thanks for taking my question. So obviously this year you had a step back in your earnings power. Just going to I'm trying to get a sense in terms of how you guys think about the achievability of getting back to 20% operating margins in earnings north of 7%. So just trying to better understand just how you guys are thinking about the profit recovery?

Speaker 3

So thank you for the We've spoken about our highest margin category and a very high margin channel being pressured. We do expect a progressive recovery in margin, but that does mean not back to 19% in fiscal 2024. And so we are taking cost actions, as we always do. We certainly have, cost control measures in place as it relates to areas like headcount, consulting expenses, other expenses as well. And we are in the process now in our August call, but it certainly will be more than 50 basis points of margin expansion off of this level, But certainly not to the 19% level.

Operator

And our next question comes from Oliver Chen from TD Cowen. Please go ahead with your question. Hi. Thanks, Fabrizio and Tracy. I was curious about what you're most concerned about for ongoing risk related regarding the inventory in the channel.

Operator

And as we think more broadly, you called out previously losing share in independent brands and opportunities in loyalty as well as customer data programs. Love your take on how that may be an opportunity going forward as well. Thank you.

Speaker 3

Yes. I mean, in terms of in the prepared remarks, Oliver, we talked about areas that we are gaining share. And so I think we are seeing strong momentum in some of the recovery markets that are gaining share inclusive of China. And China is a real indicator for what we can expect when some of the areas that have been suppressed this year like travel retail Hainan and in Korea when Chinese traveling consumers return to Korea. So I think those things are quite positive.

Speaker 3

We have strong innovation programs as well, to support our growth for certainly next year as well. And the fact again, the biggest volatility that we've seen this year has been in some of the COVID restrictions in certain markets that have been lifted. And so now it's a matter of the timing and pace of that recovery, we feel a bit better, but I'm a bit cautious, obviously, given what we've experienced this year. But recognizing that, that trigger is one that really has created as much volatility the reasons that we have already spoken about, we are feeling a bit better. There will be still volatility certainly in the Q4.

Speaker 3

And there'll be volatility next year. But we have always been a company that's been relatively good at managing volatility this year, given the severity of it and the severity in the channel of operation that had happened has caused us to have these results. But rest assured, myself, Fabrizio and the entire management team are diligently working on recovering our profitability and certainly recovering growth and our brands continue to be very strong with consumers.

Speaker 2

Yes. And just to add just for Clive, Tracey explained everything, but I want to clarify, our retail global is growing And there are very our key markets we also in growing market share. I already said it, but Want to repeat it. The market share growth in China mainland is really encouraging because we already made up all what was lost in the Shanghai closure period. The market share growth in EMEA is very strong.

Speaker 2

The market share growth in many emerging markets and emerging markets in total is very strong. I said it before, our emerging markets are growing 17%. The market is growing, but less than 17% in the sum of emerging markets. In North America, we are growing again, although not in the U. S, not yet market share, but we are growing market shares in Latin America and many other places of the world.

Speaker 2

So our demand is very strong. And the other thing that I mentioned already, there are several brands which are doing well that are very encouraging, but I believe in this quarter the key attention is on skincare. And on skincare, we have La Mer growing, Estee Lauder doing well also in China. We had double digit skincare growth in Europe and Latin America. We have single digit skincare growth in U.

Speaker 2

S, but again, back Growth. We have an exciting innovation plan, as Tracy said, but let me give you a few examples. We just launched Clinique Moso Surge 100 hours SPF, so new sun protection thing. And then The Ordinary and multi peptide serum, We have launched The Ordinary in the India and the Middle East with extraordinary results. MAC Hyper Real, meaning the Skincare market, the skincare Bobbi Brown are very strong.

Speaker 2

So all the skincare makeup brands is a new trend that we are leveraging Very well with good success. And importantly, we have our hero upgrades in the high luxury area. So La Merce, Soft Cream, Renautiva, Ultima, Diamond, which are going out, they are very important for the Asia trends where luxury skincare is growing more than skincare in general on average. So a lot of signs of strength in the fundamentals of consumption of demand of desirability of our brands are very evident. We are going through an inventory issue and with the profit pressure created by this high inventory issue and we are going to focus on sellout, retail acceleration and profit rebuilding as the next steps.

Operator

And we have time for one additional question. This question comes from Lauren Lieberman from Barclays. Please go ahead with your question.

Speaker 7

Great. Thanks. Good morning. So one thing that hasn't come up is just visibility into what's in inventory, but outside of traditional retail. And we know that, obviously, you've spoken many times over the years about travel corridor shifting and particularly now when we think about the further development of Asia travel retail broadly.

Speaker 7

But there's also shoppers that move around and buy in bulk. And there's been a lot of conversation in the industry about visibility and controls around that practice And the degree to which that was a huge driver of Korea travel retail during these lighter Regulations, let's call them, supportive measures. So I heard your comments on encouraging progression on share and retail sales be anything that you were thinking about changing controls wise to sort of have a better read on the quality of sales going out the door from some of your travel retail channels? And then finally, kind of putting a cherry on all of do you expect the inventory drawdown dynamic to be completed in the Q4? Or should we think about there still being a mismatch between sell in being down and sell through into the Q1 of 2024?

Speaker 7

Thanks.

Speaker 3

So Lauren, let me take that last one. Yes, we do expect that our sales will be down again in the Q1 and pick up in the Q2. And so, that's the cadence that we're seeing right now. Again, much depends on retail sales. And again, as we said, we're encouraged by how retail sales have picked up in Hainan, not as much in Korea at the moment, but we remain encouraged that that will happen as well.

Speaker 3

So the pace of retail, which has been slower again, that we expected this year, will determine how quickly we resume shipments. We do have Some very exciting new products that we do hope that we can actually ship them in the first and second quarter. But again, with the activities that we had going on with our travel retail partners. I believe that we'll see a continued acceleration of retail like we started to see in this quarter?

Speaker 2

Yes. And Lauren, to answer the first part of your question, we sell to our authorized retail customer. We do not sell directly to Dagoust. However, as you alluded to during COVID, there have been some temporary government policies, for example, in Korea, were put in place to support the travel businesses and the travel retailers in these very tough moments where they risk to go bankrupt because everything was closed. So Now that and you are right, there is no complete visibility on that part.

Speaker 2

There was no complete visibility on that part. What they were doing in that moment when the policies will allow this. Now these policies are changing. There is an interest of the industry in general and our retailers, which is the most important which is the most important factors in this, there is an interest in going back to regular gradually recovering. We expect a rebalancing of the total market and because of this we expect an increased visibility on all of these areas.

Speaker 2

And we are also putting extra focus, as Trezi explained before, on retail sellout on to regular travelers with new investment. We are rebuilding the people, the staff in the airports. We are rebuilding the advertising there, All what Tracy already established that with our interest is to support our retailers in this transition and we are really pushing and building this transition at the maximum speed. And so There's been during COVID less visibility, there will be more visibility in the future and more control.

Operator

And ladies and gentlemen, that will conclude today's question and answer session as well as today's presentation. If you were unable to join for the entire call, a playback will be available at 1 pm Eastern Time today through May 17. To hear a recording of the call, please dial 877-344 75,295 to 1,271. That concludes today's Estee Lauder conference call. I'd like to thank you for participation and wish you all a good day.

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Earnings Conference Call
Estée Lauder Companies Q3 2023
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