ELF review (warning: valuation discussed)

Investment Analysis Clubs Saul’s Investing Discussions
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Hi all - Some of us (still) hold ELF, which has taken quite a haircut lately (presumably) due to Ulta’s forecast that a predicted cosmetic slowdown has come earlier than expected [link here]

When something like this happens, I do my best to evaluate the “quality of the data”. Sometimes there’s news or a report and it’s more flash than substance, which can sometimes affect valuation but often valuation bounces back in a few days, but this news/revelation from Ulta deserves at least some consideration, since they’re closer to the paying customer.

Next, I look at 2 things: 1. the strength of the company/business and 2. its valuation:

  1. Company strength: ELF is strong, taking share from the other (older) brands and growing revenue, and in a very profitable way. Here’s the link to their presentation at CAGNY:https://staticcontents.investis.com/media/e/elfcosmetics/elf-cagny-2024.pdf. No concerns here.

  2. Valuation: Here’s where it gets interesting (and where I’ve been burned before). As we all know, valuation is such a tricky thing to establish. I use market cap divided by (future) annual revenue if I can get the data. But there are other ways to do it, including discounted cash flow analysis. In this case, since Loreal is a French company, I had a hard time finding their outlook revenue, so I went with TTM. And Loreal is such a large conglomerate, they sell so many different products, including cosmetics, so not sure if it’s even relevant anyway, but it’s included in the data below. Clearly ELF is priced like a market leader:
    cosmetics sector comparison

There’s an interesting free article on Seeking Alpha asserting that ELF is poised to continue taking significant market share](e.l.f. Beauty: Poised To Gain Market Share Leading To Further Upside. (NYSE:ELF) | Seeking Alpha). The upshot of the article is that ELF is oversold, and an argument is made that a reasonable valuation is $200/share perhaps in 2025.

Using my simple valuation approach, let’s estimate ’25 revenue and see what we find. In FY24, ELF is forecasted to see 70% revenue growth YoY, but projections suggest a slowdown in growth for FY25, expected to be in the high twenties range. So just going with 25% growth, we get the following:
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Just using back of the envelope math, and with the following assumptions, yields the following:

image

So using my simple valuation model also gets us in the $200 range, in 2025. Does that mean it will happen? No, unfortunately, but I still hold ELF and have not sold any, in fact.

Below is a quick look at Elf’s recent performance and their history of sandbagging:joy:, going back one year.

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Reminder ELF is expected to announce their results on 5/22/24 for their quarter ending in 3/31/24.

I’m curious how others are evaluating ELF currently.

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Thanks Gary, I have updated the Rules of the Board to clarify that while value investing is not what we are doing, discussing the valuation of our individual stocks is acceptable and useful.
Saul

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Taken from Chit-Chat Money show notes:
"If we assume 40% revenue growth and an operating margin of 25%, P/OI looks like:

41 this FY

29 in FY 2025

21 in FY 2026

So, if we assume major operating leverage and strong revenue growth, ELF Beauty will be trading at a market multiple in two years. This assumes the market capitalization is unchanged.

If we assume revenue growth slows to 20% and operating margin stays at 15% (not a crazy scenario!), P/OI looks like:

68 this FY

56.6 in FY 2025

47.2 in FY 2026

Would ELF really be trading at 47.2 in FY 2026? Any investor needs to be asking this."

A lot of ELF’s success is attributed to its marketing strategy; last quarter NonGAAP SG&A expenses increased to 54.4% of revenue’s (up from 45.4% of revenues in Q2!) – so clearly they are investing a lot in marketing to stay ahead (as expected) and they will need to continue to spend on SG&A as they now try to expand internationally. Clearly they will not keep growing at 85%, and considering their high SG&A spending (which is not going to come down anytime soon), I think there is a reasonable possibility that Operating Income margin does increase much over the next 2 years.

(I don’t own ELF)

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Good topic. One of the things I noted was Ulta stated the overall market is still growing (single-digits if I remember correctly) but not as quickly as they anticipated. They also stated part of the issue is an increase in brick-and-mortar competition near their locations, which I saw someone somewhere (maybe here) speculate is probably Sephora.

Lastly, I believe there were comments about both higher end products being pressured and/or digital sales pressuring store traffic, which would both play into ELF’s business model rather than against it.

In the end, I can’t argue with a multiple reset for ELF especially given it had more than doubled in just a few months. However, as the smallest company with the highest growth, lowest overhead, highest margins, and arguably biggest digital sales presence, it does seem ELF deserves some type of premium.

I see two possible interpretations here that likely play off each other to some extent. One is consumer pressure affecting everybody, which certainly applies if the overall cosmetics market is growing a little slower than everyone anticipated. The second is direct (stores) and indirect (digital sales) competition hitting Ulta. Unfortunately, we won’t find out how those two factors are hitting ELF until we see its next set of numbers.

There’s a chance Ulta’s problems don’t affect ELF, just like Palo Alto’s recent issues weren’t sector-related enough to affect CRWD. We don’t know for sure, but I’m not inclined to sell any based on what we know so far. In fact, I added a chunk though admittedly still with a lower allocation than some. I was at 9.2% on March 31 with the shares at $196. I’ve added enough to push it back up to 9.3% with the shares at $161. If the market lets ELF hold that P/S of 9(ish), I’m comfortable ELF will increase the denominator enough to make it worthwhile at least the next few quarters.

I don’t plan on doing anything further unless ELF gets too much over 10% of our port or the price jumps enough Bear and Saul start debating whether the valuation is too high. :rofl:

I can’t speak for others, but that’s how I’m thinking about it.

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That looks about right to me. COTY had $7.65b revenue in 2017 and only $5.55b in 2023. Not only is it not growing…it’s shrinking! Barely any growth for Estée Lauder, too.

Fiscal 2024 ended in March. (Weird fiscal year.) So we’re actually in 2025 now. I think there’s basically 0 chance growth is 25% or 27% or whatever analysts expect. This is probably why @SaulR80683 likes to say that he pays little to no attention to guidance. I think guidance can be useful for more predictable (SaaS-type) businesses, and paradoxically, I think guidance is more meaningful when growth is slower. ELF has to play the silly game of beating and raising every quarter, so maybe their initial FY guide will be in the high 20’s…but they’ll end up growing maybe something like 50%. Big beats and big raises…because they’d be foolish to predict something too close to what they know it will actually be. Especially when the (wink wink) analysts’ expectation is 20-something percent.

So to @MoneySpin’s point, the Chit Chat money guys are right:

Maybe it’s not a crazy scenario, but I think it’s highly unlikely ELF will grow less than 40% in fiscal 2025. After that, who knows, but I think where valuation goes from here depends on the trend. The error bars are wide. Will ELF be able to grow at 40% or 50% or even more for a few years? If so, it will likely become much more than a $10b company. Who knows, maybe (as the Trade Desk as done in the ad world) ELF can continue to grow at many times the rate that the overall beauty market grows. Maybe they can continue this for years. We’ll just have to see.

I’ve said before, ELF as a $5b company (in Oct 2023) was a no brainer. It’s less of one now, but there’s still a chance for them to grow more than anyone thinks for longer. TAM shmam, ok fine…but the market is there. Let’s see if they can take more and more of it.

Bear

PS – I should note that part of the 40% or 50% or more growth I expect from ELF in fiscal 2025 is inorganic. I’m sure they will grow slower in fiscal 2026. But even with slower growth at that point, they could be pushing toward $2B in revenue (just 2 years after they hit $1B)…again, impossible to predict what they can do from here.

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Hi Everyone,
I agree with Stocknovice. I think a wait and see if this approach is prudent. I’m neither pruning or adding to my 11.2% allocation. I’m optimistic for e.l.f. Beauty because,

  1. Their marketing is resonating with with their consumer.
  2. Expanding shelf space at Walmart and consistent strength at Target.
  3. International expansion (e.g. Italy) is going well.
  4. Online sales from ELF could explain some of Ulta’s marketing woes.
  5. Oddity cosmetics, which has simplified makeup purchases for the masses, could be (I think) replicated by elf to aid in further expansion.

More often than not, I have bailed too soon with growth stocks (e.g. Crowdstrike). If the business model is strong, I think it’s worth it to let the business play out. Otherwise, I could put all my money into Costco, Amazon, Exxon, Ely-Lily, and NVDA. Those are great businesses with a better line of site to the future, BUT they don’t offer as good of a chance for outsized returns.

Best,
bulwnkl

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Friday the Long term mindset guys gave a presentation that fits ELF to a t. The study was retrospective - 1980-2012 and based on a McKinsey report, so take from that what you will. The conclusion was that growth trumps profitability - you can grow your way to profits easier than profiting your way to growth. A particularly interesting slide showed that high growth (>20% revenue growth annually) and high margin (>10% EBIT margin) was good for a 23% beat relative to the market. High growth , low margin companies beat the market by 14 points and low growth, high margin companies were basically market performers.
ELF is a high-high company right now and the question is whether that can be sustained.
The data in this study says that of companies in the 100-200mm revenue category - think ELF 2015 - 40% will get to a billion if they grow at over 60% annually (super growers), whilst those growing at 20-60%, only 13% will get there.

The prize - the super growers return 5x that of the other group. I am still digesting everything, but one clear message is that the growth orientation of this board is well-supported by its members’ results and now an empirical analysis.

Vince

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