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Earlier this year, I took a look at ELF Beauty Inc. (NYSE:ELF) stock, whose eye, lip and face products have been one of the big, growing darlings of the affordable cosmetics industry, and frankly, the market as a whole.
The adoption of these affordable beauty products, especially among millennials, has created real momentum for the industry and its stock price. This momentum continues into 2024 and is entirely explained by the strong sales momentum, but the (realistic) earnings multiple is rather high here, and too high for me.
Large scale execution
Elf went public in 2016 and was trading at a mid-20% share price, offering affordable beauty products to a younger customer. At the time, the company had sales of just $200 million and operating margins in the mid-teens.
Revenues grew towards $300 million by 2019 as real progress was achieved after the pandemic. As profit margins lagged behind sales growth, shares fell relative to the IPO price. In fact, as real growth acceleration was witnessed, shares traded below $25 until the summer of 2022.
The stock ended 2022 around $50 a share ahead of the company reporting a 47% increase in revenue to $579 million and a doubling in operating profit to $68 million in fiscal 2023.
Picking up the pace
The company initially expected revenue of $705 million to $720 million and adjusted earnings of about $1.75 per share for fiscal 2024. By the time these guidance was released in mid-2023, the stock price had already risen to the $100 range. Arguably, this resulted in higher earnings multiples, but momentum was strong and the outlook was very conservative.
That showed up quickly at the end of the first quarter of fiscal 2024, when sales rose 76% to $216 million and adjusted earnings were $1.10 per share. The company further raised its guidance, but it’s still conservative, and it also announced over the summer that it was acquiring skin-care business Naturium for $355 million, which will add another $90 million to annual sales.
Second-quarter sales also grew 76% to $215 million, but adjusted earnings declined $0.82 sequentially to match the revenue numbers. The company later raised its full-year sales outlook to $900 million and now expects earnings per share to be around $2.50.
With the stock trading at $140 at the start of the year, I was trying to strike a balance. The multiple was tough based on earnings guidance of $2.50 per share, but there was also uncertainty as adjusted earnings had already reached $1.92 per share in the first half, suggesting relatively weak profitability in the second half.
I was deeply impressed with its performance and felt it was too trendy and not the right time to get in early in the year following its impressive recovery from the October lows.
I’m doing well
Elf shares have traded in a range of $150-$220 since the start of the year and are currently trading around $170, representing solid gains for investors.
This comes on the back of a strong third-quarter earnings report, with sales up 85% to $271 million and growth fueled by the acquisition of Naturium. Adjusted earnings were $0.74 per share, weaker than the first half, but it meant the company is again raising its outlook for the full year. Sales are now expected to be at the midpoint of $985 million and earnings around $2.85 per share.
The company had another strong quarter this year, with fourth-quarter sales up 71% to $321 million and full-year sales over $1.02 billion. Quarterly adjusted earnings were $0.53 per share, nearly doubling to $3.18 per share for the year. It’s important to note, however, that quarterly adjusted earnings increased by just 11 cents, lagging behind sales growth.
The reality is that Elf is unable or unwilling to grow its operating margins here, as its annual operating profit of $150 million puts its margins at just under 15%. This comes despite impressive sales growth, but it’s also a deliberate pricing strategy to continue to gain market share.
But there’s a catch: the $3.18 per share figure is heavily adjusted. It doesn’t include $40 million in pre-tax stock-based compensation expense, or $0.70 per share. After-tax earnings are likely closer to $2.50 per share.
The company outlined solid and traditionally conservative revenue guidance of $1.23 billion to $1.25 billion for fiscal 2025. What’s somewhat concerning in this regard is that adjusted earnings are expected to be flat at $3.20 to $3.25 per share, suggesting margin pressure amid slowing sales growth.
What next?
With net debt remaining flat (the Naturium deal was mostly paid for with stock, with the cash portion paid for with retained earnings), and a high market cap of around $10 billion, valuation is tough. On a sales multiple basis, the stock is trading at around 8x.
The problem is that the company, which has realistic earnings potential of $2.50 per share, is effectively trading at 70 times projected earnings, partly due to the company choosing to grow market share over short-term profits for a company that is not expected to grow earnings this year.
Given the above discussion and my belief that ELF Beauty can only achieve modest operating margin growth if it targets operating margin expansion, I am taking a conservative stance here. While I like management and their conservative guidance practices, I feel the valuation is too restrictive to commit to here.
