Estee Lauder Slips to Neutral

We are downgrading our long-term recommendation on New York-based Estee Lauder Companies Inc. ( EL - Analyst Report ) from Outperform to Neutral. The downgrade is based on negative factors like lower sales in certain countries especially in Europe and currency headwinds, which affected the company’s international performance.

Estee Lauder’s second quarter 2012 quarterly earnings of $1.00 per share, which climbed 17% year over year, missed the Zacks Consensus Estimate of $1.01 by a penny.

The cosmetics giant’s total revenue jumped 10.0% year-over-year to $2.74 billion from $2.49 billion in the prior-year quarter. Additionally, sales exceeded the Zacks Consensus Revenue Estimates of $2.7 billion.

Geographically, the company witnessed solid results in Americas (up 8%), Europe, Middle East and Africa (up 5%) and Asia Pacific (up 21%).

For the third quarter of 2012, diluted net earnings per common share, including charges associated with restructuring activities, are projected to range from 27 cents to 31 cents, while excluding restructuring charges it is projected to be between 28 cents and 32 cents. For fiscal 2012, earnings excluding restructuring charges are projected to be $2.16 to $2.23.

The company is equipped with very strong and aggressive marketing force,which promises to provide ‘High Touch’ service to its customers. Extensive sampling programs and ‘gift with purchase’ as a sampling program also help the company to promote its wide range of brands. Net expenses for advertising, merchandising, sampling, promotion and product development costs were $2,345.8 million, $2,015.9 million and $1,878.8 million in fiscal 2011, 2010 and 2009, respectively. The company also plans to increase advertising expense for the third quarter by $80 million.

The company is always geared up for newer innovations and provides its customers with all new experiences and benefits. While recent launches of Idealist Even Skintone Illuminator, Idealist Cooling Eye Illuminator and Re-Nutriv Replenishing Comfort Crème boosted skin care segment during the second-quarter, introduction of Tom Ford line of cosmetics contributed to Make Upsegment’s growth.

Fragrance segment flourished with the recent launches of Estée Lauder Sensuous Nude, DKNY Golden Delicious and Coach Poppy Flower. Hair Care segment was also booming with the help of the brand Aveda, which included the recent launch of its Invati line of products. These series of innovative launches coupled by aggressive promotion offset the macro-economic headwinds, fuelling lower spending of the customers

However,the general economic downturn has affected the company’s top-line results. As consumer purchases of discretionary items tend to decline during recessionary periods, when disposable income is lower, the company’s sales may be affected. Moreover, the company gave lower third quarter 2012 earnings forecasts, which missed the analysts’ expectations.

The company, whose majority sales came from overseas, said that it assumes some slowdown in sales of more expensive beauty products overseas, particularly in Europe, Japan and Australia, due to recent economic uncertainty and volatility in the financial markets. The outlook also assumes slower growth for the Chinese economy.

Moreover, intense competition in both domestic and international markets from other established players, such as L’Oreal S.A., Shiseido Co. Ltd., LVMH Moet Hennessey Louis Vuitton and the Procter & Gamble Co ( PG - Analyst Report ) poses headwind for the company. Estee Lauder also competes with a number of independent brands and private label products of certain retailers. Consequently, the company is under pressure to maintain profitability

Estee Lauder currently retains a Zacks #3 Rank, which translates into a short-term Hold rating with a long-term Neutral rating.