E.l.f. Beauty (ELF) introduction

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e.l.f. Beauty is a cosmetics company that is growing at an incredible rate. They are taking significant market share from competitors and have some disruptive competitive advantages.

I have a small position in this one. It’s not normally an industry I’d be interested in investing in, however the numbers are shockingly good. Just looking at the graph of the last year you can see there is a huge jump up after each earnings.

From their fiscal Q1’24 earnings (August 1) they modified their full year guidance for fiscal 24 as follows,

Net sales 705-720M → 792-802
Adj EBITDA 144.5-147.5M → 171-174
Tax rate 21-22% → 17-18%
Adj net income 98.5-100.5M → 125-127M
Adj EPS 1.73-1.76 → 2.19-2.22

Note that their net sales guidance for the full year is going from 22-24% growth to now 37-39% in a single quarter! The new outlook on EBITDA changes from 24-26% growth previously to 46-49% growth.

Here are some notes from the last conference call,

  • Grew net sales by 76%
  • Increased gross margin by 280 basis points
  • Delivered 74M in adj EBITDA up 135%
  • ELF grew 48% in tracked channels, well above category growth of 6%
  • Increased market share by 260 basis points
  • In Q1 ELF skin grew 127% in tracked channels, well above category growth of 10% and was the fastest growing among top skin care brands
  • International net sales grew 79% led by UK and Canada
  • Three drivers of growth: value proposition, powerhouse innovation, and disruptive market engine
  • Launched Poreless Putty Primer priced at “incredible” value of $10 compared to competitors around $54
  • While beauty is a category of comparatively low barriers of entry, very few brands have been able to scale
  • ELF has premium quality products at accessible price points with board appeal that are vegan, cruelty-free, clean and Fair Trade Certified
  • Our supply chain offers the best combination of cost, quality and speed in our industry
  • Supply chain is integrated with innovation engine to launch “franchise building Holy Grails”
  • Engagement model gives ability to activate millions of consumers against this innovation
  • Digital channels drove 18% of total consumption in Q1, compared to 14% year ago
  • Loyalty members drive about 80% of sales on elfcosmetics.com and continue to have higher average order values, purchase more frequently, and have strong retention rates
  • Saw cost savings, lower inventory adjustments, improved transportation costs, which more than offset space expansion
  • Q1 Adjusted net income was 63M compared to 21M year ago
  • Continue to expect gross margin improvements
  • Analyst said: “You beat your soft guidance or consensus by about $30 million, but you are raising your full year by an even greater $85 million”
  • Seeing strength across our entire business
  • Marketing is working and see plenty of opportunity
  • Space expansion coming in the Fall with Ulta, CVS, and Walgreens
  • Feel great about supply chain and the advantage with cost, quality and speed
  • We are pleased with the outlook in gross margins of 150 basis points increase, which is on top of 320 basis points of improvement in gross margin in fiscal ‘23
  • The team being built in the UK has identified a number of countries they can enter
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I have a 25 year-old daughter who is fashion conscious and very interested in influence culture. Texted her on this and she wrote back, “Huge thing, everyone uses all, I do a ton, many loyalists” And my wife added “even I know about that” from the older generation. For me this gives the idea serious legitimacy. “quality make up at super cvs prices” - with consumers strained and brand established this real good story out of gate. First I heard of it fwiw.

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I have to double-check but looks like inside ownership might be at about 4.5%

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I stumbled across ELF while doing some DD on ODD, which recently IPOed. I found this article in the WSJ very interesting. Especially keeping in mind, that AESOP just been bought bei L‘oreal for 4,7x 2022 revenue. ELF has a multiple of 10,00 EV/S and ODD 5,3 EV/S LTM.

Viral Makeup Company’s Valuation Looks Oddly High - WSJ
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Source: The Wall Street Journal

I do understand, that ELF might earn a premium valuation, but with the huge run-up over the last 12 months the valuation seems to be on the very steep end.

Viral Makeup Company’s Valuation Looks Oddly High

Best
Nick

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Taking Peter Lynch’s advice, I checked with an authority on these things (teenage girl):

She said, “I would say that ELF is pretty popular. It’s not the best out there of all the makeup companies, but they are up there. And they have a lot of their products in Walmart, Target, Ultra (sic), a lot of popular places”.
I asked if the “trendy” people are wearing it. She said, “Yes. Their primer and setting spray are some of the best in the makeup business”.

Then she went on to ask why I want to know. It was an opportunity to share the concept of investing.

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While some of those numbers look interesting, I have one big question: How much of the high growth is because the company has a good business model with good leadership and how much of the growth is because their products are trendy?

Fashion and social trends are fickle by nature and can change rapidly in the modern world of social media. As an investor this adds a largely unpredictable uncertainty factor which could lead to stock price drops for no business related reason. Is this a large risk here, or is there a more concrete reason to believe this growth will continue?

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EDIT: I looked up some more information about the CEO Tarang Amin, here is his bio on the corporate page,

Tarang has served in his current role at e.l.f. Beauty since 2014. He has more than 25 years of consumer products experience building brands, leading innovation, and assembling high performance teams. Previously, Tarang served as President, Chief Executive Officer and Director of Schiff Nutrition (NYSE:SHF) where he grew enterprise value from $190 million to $1.5 billion with leading brands such as Airborne and MegaRed. Prior to Schiff, Tarang served as Vice President, General Manager of The Clorox Company’s $1.7 billion Litter, Food and Charcoal businesses. He began his career at Procter & Gamble where he held various management positions. Tarang earned his B.A. in international policy and M.B.A. from Duke University.

The company went public in 2014 so the company was taken public under his leadership. Looking back at the growth rates from 2016 to 2020, it wasn’t a high growth company with most quarters growing between 10 to 25% year over year.

This growth is new and is ramping up post-IPO rather than saturating the market after going public.

I like what the CEO is saying about scaling in their last call,

While beauty is a category of comparatively low barriers of entry, very few brands have been able to scale.

For context, of over 1,800 cosmetics and skin care brands tracked by Nielsen. Only 58 have surpassed $25 million in annual retail sales over the past 3 years, and only 28 are greater than $100 million. e.l.f. has been one of the few brands able to scale through the areas of advantage we bring to the table.

With e.l.f. consumers can have premium quality beauty products at accessible price points with broad appeal that are vegan, cruelty-free, clean and Fair Trade Certified. These superpowers are underpinned by several other areas of competitive advantage. Our supply chain offers the best combination of cost, quality and speed in our industry. and is well integrated with our innovation engine to launch franchise-building Holy Grails. Our engagement model gives us the ability to activate millions of consumers against this innovation.

And perhaps most importantly, we have a talented high-performance team and culture. While other beauty brands can try to replicate some of these, we believe the unique combination of our areas of advantage form our competitive moat.

Also I don’t see any reason the company couldn’t scale to the same size as an Estee Lauder (EL), which has roughly 10x the market cap of ELF.

Somehow these two companies have about the same P/E ratio but Estee Lauder has no growth. Is there some reasonable explanation why ELF has a P/E of 65, and EL has a P/E of 54?

I thought maybe EL was still growing but here’s highlights from their last call,

  • We delivered an organic sales increase of 4%
  • Our global travel retail business decreased 34% organically in fiscal year 2023
  • The rest of our business in total rose 5% organically as growth accelerated from 10% in the third quarter to 17% in the fourth quarter
  • We had a challenging year
  • Our fourth quarter organic net sales increased 4% and earnings per share was $0.07
  • In EMEA, organic net sales decreased 15%
  • Organic net sales increased 6% in Hair Care and declined 3% in Skin Care
  • Our gross margin declined 330 basis points compared to last year
  • Operating expenses increased 390 basis points to 59.9% of sales, driven primarily by the decline in sales
  • Our effective tax rate for the year was 26.5% compared to 21.3% last year
  • I want to take a moment to first address the recent cybersecurity incident we disclosed in July, involving an unauthorized third-party that gained access to some of our systems
  • For our first quarter, we currently expect organic net sales to fall 12% to 10%
  • In constant currency, we expect EPS of negative $0.29 to negative $0.19

Just look at the massive gap between these two companies. Net sales of skin products for EL decreased 3%, and ELF skin care grew 127% over the same period!

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I bought ELF over a year ago and am happy to say has grown into my 2nd largest position. And I confess they converted me into a faithful customer of its products (and I’m an old gal, clearly not their target market). That said I keep a sharp eye on the company and because of its accelerating share price I think it is fairly high risk.

I bought ELF because of its diverse leadership team.Its board and leadership have a very high percentage of women and minorities in key positions who appear to be very capable. And Tarang, who is dedicated and very well qualified, wants his brand managers and marketers to represent its target markets.

They have a very capable research team that brings to market a wide range of products in a timely way at extremely competitive price points. I believe there is plenty of growth opportunity in men’s skin care, fragrances, beauty tools and marketing gen x, boomers, etc. I believe mature women who used to go to department stores to buy prestige make up (like me) don’t go to Saks and Nordstrom for that anymore and rely on online shopping or pick up supplies when they are in Target or in the grocery for other items. Tarang has said they are taking share from prestige brands and I believe it.

Tarang has mentioned more than once that they are willing to consider acquiring well managed companies that share their vision that will provide market share growth. (This is how L’oreal and Louis Vuitton and other highly successful beauty brands achieved phenomenal growth.) and I believe he is capable of shepherding those opportunities (given his solid brand management training at P&G.).

Its visionary founders included digital marketing very early on in their business plan when they realized it was an effective and inexpensive way to reach national and international markets. More recently the company has shut down their (20?) free-standing stores to raise cash to expand their online marketplace and to develop their presence in Target, Walmart, Ulta and other large retailers. They are developing their online Influencers network and expanding their direct to consumers logistics network. This plan is responsible for the huge revenue growth in recent quarters.

Two concerns are on my mind besides the run up in share price, though:

  1. The founders sold out their shares early in 2023 and their original venture funder sold out in 2023 as well.
  2. every time I go in to Target Ulta or Walmart I check the E.l.f. Shelves and typically they are nearly empty. Is that a good thing or a bad thing? They said in one conference call when asked about that that they are working diligently on supply lines after covid disruption. I am watching that.

Anyway, it is an interesting and fun company to follow. The leadership is young and dynamic, and my 5 nieces use and love the products. ELF is the first stock that I got them to buy as a result of my investment ‘mentoring’ hobby. It is high risk, however, but hopefully high reward, so tread carefully.

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Yes! Elf Beauty just announced purchase of skin care company, Nasturtium. This acquisition will really accelerate their growth IMO. Stock up 5% this morning.

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Wow you said it. Thanks for bringing this one to the board. As you said, the numbers are remarkable. Here’s the last couple years, starting with the most recent quarter on the left:

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ELF struggled for years to get from ~200m to ~300m in annual revenue, but after the pandemic they cruised from $318m in f2021 to $392m in f2022. But something inflected in f2023, because they soared 48% YoY to $579m revenue. The stock has of course re-rated and quadrupled in just over a year. Now we’re in Q2 of f2024 (Q1 ended in June – their fiscal calendar is weird). The last two quarters revenue has grown 75%+ YoY.

Maybe even more interesting, EPS has grown even more than revenue. GAAP EPS was up 244% in Q1, non-GAAP 182%. That’s pretty much a triple. I would expect EPS growth to be closer to revenue growth in coming quarters, though…in Q1 they were already around ~30% net margin. Still if $1.10/quarter is anything like a run rate for them, that’s 4.40/year and would mean their run rate PE is about 30. That’s a pretty nice PEG while growth is 75%+!

So how has this been happening? I think @XMFPennyWise gets it right:

ELF says in their materials that they are gaining market share vs their mass market peers like Maybelline or Covergirl, which I am told are no longer cool (while ELF is). I wonder if they’re also expanding the mass market, since some of their hot products are clones/dupes of high-end brands’ products – which ELF makes available at a fraction of the cost, of course. The social media / influencer thing seems to be really crushing it for them too. Whatever the cocktail that has led to the last several quarters’ acceleration…it’s working.

I’ve taken a position and I’m excited to see where this goes. Again, thanks for bringing it to the board, @wpr101!

Bear

PS - Next report, Q2, is their seasonally down quarter (for some reason), so sequentially revenue is actually expected to be negative. What I’ll be watching is, can they raise their FY guide anyway (like it seems they always do)?

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In various cc and interviews ceo talks about taking share from the premium brands like Laura Mercier, Chanel, etc. and I believe that. Also, their new acquisition is positioned to steal market share from high end beauty treatment brands.

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If I’ve got it right, they also had a recent acquisition right?. If so, it’s possible the number will be higher regardless in the headlines, and we will need to wait for management’s comments on the organic breakout.

(Please let me know if I don’t have that right. I’m going a bit from memory on that one.)

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CNBC Interview from two weeks ago…

“Biggest acquisition in your history…what exactly did you like?”

JabbokRiver
No position

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I just went in to CVS today and chatted up the asst manager about E.l.f. She said just this week they moved the ELF display to front and center position and greatly enlarged the shelf space. She said it was very very popular. I did not see a Naturium display, so that is yet to come. Naturium has an 80% revenue cagr over two years, so no laggard. Their masstige position in the market presents synergy opportunities. . On the Investor Relations page there is a video giving lots of detail about the acquisition. https://investor.elfbeauty.com/sites/elf-ir/files/2023-08/e-l-f-beauty-naturium-investor-presentation.pdf

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I also took a small position based on the exceptional numbers.

But I was still left wondering why those numbers came to be, and specifically what caused the acceleration of recent years. I wondered whether they perhaps had an acquisition juicing the numbers in there.

Turns out it’s essentially all marketing - and good marketing at that.

Sounds like the company was flatlining in 2017/18 which led them to execute a marketing pivot in 2019 towards online/digital marketing (Tiktok specifically) and GenZ, which lined up pretty nicely - and just in time - for the pandemic years starting 2020, when GenZ (and the rest of us) were basically glued to our screens. Here’s a short overview of what they did from earlier this year, which I found worthwhile.

The agency largely responsible for the execution was Movers & Shakers and they have a good overview of what they did and why it worked here

Marketing can be a potent source of competitive advantage and can have quite a bit of longevity.

-wsm

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The acq is expected to close around 9/30 which is the last day of the quarter, so no, I wouldn’t expect that to affect revenue much at all. It will certainly allow them to raise the guide, and hopefully they break that out and explain how much is expected to come from Naturium specifically.

Bear

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Per ELF’s latest 10-Q, they had this to say about seasonality. “Our results of operations are subject to seasonal fluctuations, with net sales in the third and fourth fiscal quarters typically being higher than in the first and second fiscal quarters. The higher net sales in our third and fourth fiscal quarters are largely attributable to the increased purchasing levels by retailers for the holiday season and customer shelf reset activities, respectively. Lower inventory builds from our retailers in preparation for the holiday season or shifts in customer shelf reset activity could have a disproportionate effect on our results of operations for the entire fiscal year. To support anticipated higher sales during the third and fourth fiscal quarters, we make investments in working capital to ensure inventory levels can support demand. Fluctuations throughout the year are also driven by the timing of product restocking or rearrangement by our major retail customers and expansion into new retail customers. Because a limited number of our retail customers account for a large percentage of our net sales, a change in the order pattern of one or more of our large retail customers could cause a significant fluctuation of our quarterly results or impact our liquidity.”

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