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Stock Market Sell-Off: Is Estée Lauder a Buy?

In light of the broad market’s weakness, it’s been a surprisingly OK year for beauty stocks. Shares of e.l.f. Beauty are up 19% since the end of 2021 despite the bearish start to 2022, and owners of retailer Ulta Beauty are essentially breaking even year to date. That’s still a victory given that the S&P 500 is down more than 20% for the same period. Coty remains in the red for the year but has still rallied more than 30% from June’s low.

There’s one notable exception to the industry’s sweeping strength, however. Shares of The Estée Lauder Companies (EL 1.71%) are down 36% year to date, and they’re knocking on the door of new 52-week lows. Guidance for the fiscal year beginning in July was anything but thrilling, rekindling the stock selling from earlier in the year.

It’s arguable, however, that the cosmetics company was simply ensuring relative success by underpromising so it could overdeliver. So this year’s sizable pullback could be a buying opportunity. Let’s take a closer look.

China is the sore spot

Blame what’s happening in China, mostly. In a normal year, roughly one-fourth of Estée Lauder’s top line comes from the Asia/Pacific region, which is by and large China. But with significant shutdowns prompted by a lingering COVID-19 problem there, the need for makeup has been stifled. Retailers’ capacity to get it and consumers’ ability to buy it are also crimped.

End result? The sales rebound that began taking shape in the latter half of last year was upended by a new round of shutdowns this year. On a constant-currency basis, Estée Lauder’s Asia/Pacific sales fell 19% year over year during the quarter ended in June, following the previous quarter’s dip of 3% for the region. 

That isn’t horrible until you compare it to the 16% sales growth that Estée Lauder experienced in the rest of the world for the first of those three-month stretches and to essentially flat sales for the ensuing quarter.

Worried that this new headwind could worsen before waning, the cosmetics company in August issued uncomfortably conservative guidance for the current fiscal year. Specifically, Estée Lauder anticipates total revenue growth of only between 3% and 5% for fiscal 2023, and organic sales growth of between 7% and 9%. Likewise, the earnings projection of between $7.39 and $7.54 per share is only about a 6% improvement on last year’s bottom line. The market clearly wanted more.

The funny thing is that investors may ultimately end up getting what they want.

Riper for a rebound than it seems

It’s impossible to know when the coronavirus contagion will fully and finally wind itself down. It’s also impossible to know how China’s governmental authorities will ease the country out of the lockdowns that reflect its government’s “zero-COVID” mindset. 

We do know, however, that August’s surprisingly tepid inflation rates in China suggest economic weakness. This weakness is, in turn, prompting some of the nation’s more senior government officials and business leaders to voice concerns, even if they could be construed as criticisms of how the contagion is being handled.

It may be working. While the nation’s government would never admit to a mistake, just a few days ago China’s National Development and Reform Commission announced new measures meant to stimulate the country’s economy. These measures include the acceleration of planned construction projects, capital injections, and more serious discussions of how the country could induce more consumer spending.

It’s also worth noting that while some slivers of the country’s economy are struggling, China’s retail sales were still up 5.4% year over year in August; clearly, at least some consumers are finding ways to spend their money despite the logistical challenges linked to lockdowns.

History says opportunity is knocking

Is this a rock-solid guarantee of expectations-beating growth ahead? Hardly. There’s no such thing. But it’s certainly not a stretch to say the market is overreacting to what should ultimately be short-lived turbulence. Estée Lauder is a perennially strong performer with or without China, and there’s no fundamental reason to believe the cosmetics company won’t overcome its current challenge.

As Goldman Sachs analyst Jason English put it when Goldman upgraded Estée Lauder stock earlier this week, “This uncertainty is around a dynamic that we believe will prove transitory.” He adds, “History has taught us that stock price weakness[es] related to transitory events are typically buying opportunities, especially when they overshadow an otherwise improving outlook.”

In other words, the stock’s year-to-date slide of 36% makes for an appealing long-term entry opportunity.

James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs and Ulta Beauty. The Motley Fool has a disclosure policy.

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