The best thing is to look natural, but it takes makeup to look natural.
– Calvin Klein
These are trying times. The stock market has seen its worst week since 2008, and there are fears that the Covid-19 pandemic will require cautionary measures for a year, if not longer. In these conditions, the companies that are likely to survive will be those with strong balance sheets and large cash reserves. Yes, the signals in The Lead-Lag Report went risk-off January 27 and stayed that way throughout this period. Yes, the signals are also getting close to suggesting risk-on is coming in the short term. Long term though, investors are still investors who should be on the lookout for opportunities, and Estee Lauder may be one of them.
Estee Lauder, with 84% of its revenue coming from skincare and makeup, is considered a consumer staples stock, falling under non-durable personal products. Despite being in the consumer defensive sector, it has only recorded a roughly 3% lower drop than the S&P 500 Index and a 7% greater loss than the S&P 100 Consumer Staples Index.
Initially, the share price began to drop as Estee Lauder trimmed its EPS forecasts for 2020 on February 6, based on the impact of Covid-19 in China reducing demand in an important market for it. On March 18, the company scrapped guidance altogether as it took stock of the larger impact that Covid-19 could have on its global operations. It is also sitting on a 24.31 12-month forward P/E versus an 18.42 12-month forward PE for the S&P 500, which suggests the company is overvalued. In addition, with its traditional retail stores shuttering and a key driver of its revenue – travel retail – set to be significantly impacted, the short-term outlook is worrying.
So why choose it as a stock? As mentioned in the opening paragraph, a strong balance sheet and large cash reserves are key to surviving this world crisis. In the last reported quarter, Estee Lauder had $3.6 billion in cash and short-term investments and a current ratio of 1.685. While other companies are likely going to have to restructure their short-term debt, Estee Lauder will be able to survive without taking that action. It also had a free cash flow of $1.26 billion in the last reported quarter, although this is likely to decline with the current global social and economic situation. In addition, the company’s times interest earned in the trailing 12-months was 34.62, further emphasizing its liquidity strength. And in terms of bankruptcy risk, its Altman-Z score is at an impressive 5.78.
There are two other aspects which also make it look like a good stock to buy. Firstly, in the short term, retailers have been able to shift their traditional retail stores into online stores, which should significantly mitigate the social distancing rules put in place in most countries. While this will not help the company’s revenue from travel retail, it will allow a substantial quantity of its traditional revenue stream to remain intact, albeit from a shift in buying sources.
The second aspect is that Estee Lauder was showing strong earnings growth. In the 2019 financial year, it recorded earnings growth of 60.72%. The estimated EPS for the next quarter is still $1.16, indicating that, despite the current climate, the company is still likely to generate profits. And once the crisis is over, it will likely return to the sphere of high earnings growth.
In conclusion, in this critical time, Estee Lauder meets two important criteria: a strong balance sheet and large cash reserves. It is also likely to continue to create profits despite the economic climate. As such, this is a stock to buy, although the hold period before investment returns are made may make some investors uneasy.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This writing is for informational purposes only and Lead-Lag Publishing, LLC undertakes no obligation to update this article even if the opinions expressed change. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services in any jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Lead-Lag Publishing, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.