e.l.f. Beauty (NYSE:ELF) has become one of the market's strongest growth stories in the consumer space over the last two years. From the beginning of 2022 to the June 21, 2024 market close, the stock has risen 520% due to rapid revenue growth and its ability to take market share from competitors. Chief Executive Officer ("CEO") Tarang Amin said on the company's fourth quarter fiscal year ("FY") 2024 earnings call, "We are one of only five public consumer companies out of 274 that has grown for 21 straight quarters and average at least 20% sales growth per quarter."
The company has become extremely popular among teenagers. The 47th semi-annual Piper Sandler Taking Stock With Teens Survey released in April 2024 stated, "e.l.f. Beauty continues to dominate the [beauty] space, ranking number one among teens in addition to ranking in the top 10 skincare brands and beauty destinations." It was the fifth straight year that it ranked number one.
The company is well known for selling prestige quality cosmetics at prices where its customers see value. Seeking Alpha posted an article on June 18 that quoted Canaccord Genuity Sr. Wellness and Beauty analyst Susan Anderson: "Overall, we still believe ELF is in the early innings of its growth story as the brand still lags the legacy brands around brand recognition and even shelf space depending on the channel." Canaccord Genuity also raised ELF's price target from $214 to $250.
All of the good news and positive sentiment around the company means that the company is not unknown among investors. The stock is up close to 43% year-to-date as of the June 21 market close. It sells at a valuation far above its peers, and some consider the stock overvalued. Investors buying ELF at the current valuation risk a steep decline in stock price if the company disappoints, which is a possibility if the U.S. Census Bureau keeps reporting weak retail sales numbers. Investors are also concerned about management's light FY 2025 guidance for net sales.
This article will briefly discuss the company's brands, how ELF (short for eyes, lips, face) became one of the fastest-growing consumer products companies, and review its fourth-quarter FY 2024 results. It will also discuss a few risks, the company's valuation, and why I believe the stock is a hold.
The company owns five brands
The company's primary brand is e.l.f. Cosmetics, which markets a category of products that the beauty industry calls color cosmetics (makeup) for the eyes, lips, and face. Management established a second brand, e.l.f. SKIN, in 2015 to address the skincare market. The company's main website allows potential customers to shop for each brand separately. The last three brands on the above list are ELF's subsidiaries and have separate websites from the company's main website.
ELF acquired Naturium, a skincare brand, in 2023. Naturium is a clinically focused skincare brand, meaning it uses clinical studies to verify its products will do what it claims. As a result, consumers who engage in deep research before buying a skincare product will likely be more attracted to this brand over e.l.f. SKIN. Additionally, Naturium has a different demographic. A higher percentage of male customers (40% of their users are men) use the product; it's popular with millennials and is at a higher price than the e.l.f. SKIN brand. ELF has historically been popular among teens, and adding a popular millennial brand should help the company become more multigenerational. Naturium's website remains separate from the main e.l.f.-branded website.
ELF acquired W3LL PEOPLE, also known as Well People, in 2020 to expand further into "clean beauty." These products are made with natural, environmentally friendly ingredients and exclude potentially harmful ingredients like propylene glycol, petroleum byproducts, toxins, sulfates, parabens, or potentially cancer-causing chemicals. This brand is attractive to customers with existing medical conditions or people who want to maintain a healthy lifestyle. Well People also maintains a separate website from the primary brands.
Keys Soulcare is a joint venture ("JV") between the singer and actress Alicia Keys and ELF, launched in the U.S. market in 2020. The JV sells skincare, makeup, and body care products and uses an independent website from ELF's primary brands.
The company's incredible rise
Scott Vincent Borba, a long-time beauty industry professional, and Joseph Shamah, a business student, founded the company to fill a market need for high-quality, innovative makeup at a low price. One of the founders, Scott Borba, got the idea from watching wealthy women drive expensive cars to dollar stores to shop for low-cost makeup. Borba recognized a consumer desire for prestige quality makeup at inexpensive prices. Thus, e.l.f. Beauty was born in 2004 to fulfill that consumer need.
Still, it took a while for ELF to really catch on. The company became publicly traded on Sept. 22, 2016, with an initial public offering ("IPO") price of $17. The stock rose 87% from its IPO price to $31.74 in November 2016 and promptly stagnated. By early 2019, the stock was trading in the single digits as quarterly year-over-year revenue growth turned negative, and sentiment was gloomy as the company's sales underperformed. It took until mid-2020 for the company to finally rise above its IPO price. Since then, it has never looked back. The post-pandemic beauty boom was a tailwind for the company. By the start of 2022, quarterly revenue growth shot higher, and the stock rose in line with the massive jump in revenue growth.
Currently, ELF is one of only five companies in the cosmetics industry with more than $700 million in retail sales. Even at its current scale, it continues to gain market share against the industry's most established players in color cosmetics (makeup), its primary branded products. Chief Executive Officer ("CEO") Tarang Amin said during the fourth quarter FY 2024 earnings call:
Today, e.l.f. has the number one or two position across 18 segments, which collectively make up almost 80% of e.l.f. Cosmetics sales. We continue to deliver strong sales growth and share gains across these segments.
As of the fourth quarter of the FY 2024 report, the company was number two in dollar share and number one in unit share in color cosmetics. The best part is that management is confident that it can continue outgrowing the color cosmetics category and taking share from competitors.
Next is the skincare market. Since ELF only entered skincare in 2015, it is further behind the color cosmetics category regarding market share. CEO Amin said the following about skincare on the fourth quarter FY 2024 earnings call:
While we've tripled our [skin care] market share over the last five years, we remain significantly underpenetrated today. For context, as compared to the 10.5% share we have in cosmetics, we have less than 2% share in skin care.
Today, ELF has a brand rank of #11 in skin care, increasing from #14 in the previous year. Management believes it can do the same thing in skincare as in color cosmetics, reaching the top spot. Some investors are bullish on ELF because it still has significant room for growth in the skincare category and is already significantly outpacing it. The image below compares ELF's skincare business' fourth quarter consumption rate of 38% to the Skin Care category rate of 2%.
Management also identified international growth as an area with a significant runway for growth alongside Color Cosmetics and Skincare. The company grew fourth-quarter international sales 115% year-over-year in its fourth quarter FY 2024, fueled by growth from the U.K. and Canada. The following chart shows that the company rose three spots in the rankings in both the U.K. and Canada over the previous year.
Its international business grew from 13% of the company's net sales in the fourth quarter of FY 2023 to 16% in the fourth quarter of FY 2024.
ELF fourth quarter FY 2024 and annual FY 2024 results
Although ELF started as an online-only store in 2004, today, the company primarily sells its products to national and international brick-and-mortar retailers. In FY 2024, 84% of the company's annual net sales came from national and international retailers, and 16% came from e-commerce.
Canadian consumers can find ELF products in Shoppers Drug Mart, London Drugs, and Walmart Canada, among a few other retailers. European consumers can find ELF products in U.K. stores, such as Superdrug and Boots. Outside the U.K., European brick-and-mortar retailers that sell ELF products are sparse, as the U.K. is the company's most advanced market in Europe. The company only recently entered Italy and started selling its brands online and offline at Douglas in late 2023. Amazingly, it is already that retailer's number-one brand.
The company also has operations in the Netherlands. It launched its products in April 2024 in the largest health and wellness brand in the Netherlands, Etos. It has already become the number one brand in that retailer, too.
The European story is still early, and as the company gains shelf space in more European retailers, the potential for rapid sales growth is high.
Currently, the largest retail outlets for ELF are within the U.S., with Target (TGT), Walmart (WMT), and Ulta Beauty (ULTA) accounting for 25%, 17%, and 16% of FY 2024 net sales. It would be in the best interests of ELF investors to follow how many retailers the company can establish a presence in and how much shelf space, measured in feet, the company can garner. Gaining a few more feet of shelf space in a major retailer like Target or Walmart could translate into more consumer awareness and millions of dollars in sales. The company gaining more shelf space in a big retailer can sometimes spur stock upgrades as analysts raise their revenue estimates or ratings based on such news. For instance, Davidson recently put ELF on its Best-of-Breed Bison list. Davidson expects the company's impressive numbers to continue after shelf space gains at Target and Walmart. When you look at the company's impressive quarterly and yearly numbers below, understand that a significant reason for the outsized sales growth is its success in grabbing shelf space in major retailers.
ELF's fourth quarter FY 2024 net sales grew 71% year-over-year to $321.1 million. Annual net sales grew 77% year-over-year to rise over $1 billion in annual sales for the first time.
Fourth quarter gross profits grew faster than revenue at 76% year-over-year, as gross margins expanded 183 basis points year-over-year to 70.75%. The improvement in gross margins was due to several favorable factors. Chief Financial Officer Mandy Fields said the following about gross margins on the earnings call:
We saw gross margin benefits from favorable foreign exchange impacts, price increases in our international markets, lower costs from retailer activity, cost savings and mix, partially offset by inventory adjustments. We also saw a benefit from improved transportation costs, albeit to a much lesser extent than the prior three quarters, as we began to annualize some of the benefits that flow through in Q4 last year.
The price increases in international markets and increased sales volume are signs that the company may have pricing power in its operations in foreign countries -- a potentially good thing for future profitability if it can maintain pricing power. Lower costs from retailer activity mean ELF likely negotiated better prices for promotions, distribution, or shelf placement from retailers. Better margins from "mix" means that it sold more higher margin products during the quarter than lower margin products. "Improved transportation costs" means that the company found savings in shipping products manufactured in China to its selling location. These costs could include shipping and fuel costs, warehouse storage fees, customs duties, and taxes. All of the above improvements augur well for increased profitability if they continue.
The company generated a fourth-quarter GAAP (Generally Accepted Accounting Principles) operating income of 17.03 million and a GAAP net income of 14.53 million. GAAP diluted earnings-per-share ("EPS") was $0.25, which beat analysts' estimates by $0.04. Although the company is profitable on a GAAP operating and net income basis, the company prefers to give guidance on a non-GAAP basis, likely because the company has many one-time costs. Management reports non-GAAP EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and non-GAAP adjusted income, as these profitability numbers may be more comparable from period to period. The following is a reconciliation of GAAP net income to non-GAAP adjusted EBITDA.
According to the above numbers, ELF's fourth-quarter FY 2024 adjusted EBITDA margins grew 140 bps year-over-year to 12.74%, and its annual FY 2024 adjusted EBITDA margins grew 275 bps year-over-year to 22.92%.
The following table shows a reconciliation of GAAP net income to non-GAAP adjusted net income.
According to the above numbers, ELF's fourth quarter FY 2024 non-GAAP adjusted net income margins declined 311 bps year-over-year to 9.6%. Its annual FY 2024 non-GAAP adjusted net income margins grew 209 bps year-over-year to 17.95%.
The company's fourth quarter FY 2024 adjusted diluted EPS was $0.53, beating analysts' estimates by $0.20. Its annual FY 2024 adjusted diluted EPS was $3.18, up from $1.66 in the previous year.
The following table shows management's guidance for FY 2025.
Management calls for FY 2025 net sales of $1.24 billion at the midpoint of the guidance range, which would be 21% year-over-year growth. These numbers disappointed Wall Street, which still forecasts FY 2025 net sales of $1.29 billion or 25.97% year-over-year growth. The stock rose 18.7% the day after the company released earnings, indicating that optimistic investors may not fully believe in management's conservative guidance. Still, there are reasons to be cautious. Ulta Beauty warned investors of a slowdown in the beauty business in early April. In late May, the CEO of Ulta indicated that a downturn in the beauty industry could persist throughout the year.
ELF ended its FY 2024 with $108.18 million in cash and short-term investments and $161.81 in long-term debt. The company has a net debt-to-EBITDA ratio of 1.03. Generally, the lower the net debt-to-EBITDA ratio is below 3.0, the lower the chances a company will default on its debt. It has an interest coverage of 21.3 for FY 2024. The number indicates that ELF produced more than enough EBIT (Earnings Before Interest and Taxes) to cover its interest expenses in the last fiscal year. ELF has a debt-to-equity ratio of 0.408, which means the company has strong financial stability.
Risks
The economy remains weak, and a recession is still not out of the question. The U.S. Recession Probability is 51.82%, higher than the long-term average of 14.80%.
Part of the reason management guided net sales lower than Wall Street analysts is likely that there is a credible possibility that the economy could turn south in the short term and slow ELF's sales growth. If the company disappoints in its sales numbers in the next several quarters, investors may react negatively to the stock at its current valuation. That is a short-term risk of investing in the stock today. There are other longer-term risks.
Virtually all of the company's products are sourced and made in China, which involves numerous risks, including supply chain disruptions, the difficulty of enforcing quality control, regulators banning the import of certain cosmetics products due to health concerns, and the difficulty in tracking the source of all the ingredients in a cosmetic product. The last issue burned ELF between 2012 and 2017 when the company reportedly imported products containing material from North Korea, which violated the law. ELF had to pay a $996,080 settlement to the U.S. Treasury Department's Office of Foreign Assets Control in 2019.
The cosmetic and skincare industry is highly competitive and has a low barrier to entry. According to IBISWorld, there were "4,172 Cosmetic & Beauty Products Manufacturing businesses in the U.S. as of 2023." ELF faces competition from established brands with a more significant retail presence in physical stores to innovative online startups backed by celebrities or influencers.
ELF fights for finite space on shelves for its products in retail stores against companies with more financial resources and prominent brands. For instance, it competes against L'Oreal (OTCPK:LRLCF), the largest cosmetics company in the world, which owns popular brands like Maybelline, Garnier, and Urban Decay. The company also competes against some influencers for shelf space in stores. For instance, Kylie Cosmetics, partially owned by Coty Inc. (COTY), has a shelf presence in Ulta Beauty (ULTA) physical stores. ELF also battles online against an army of influencers and celebrities from YouTube, Instagram, and other social media networks for online sales. A failure to gain more space on retailers' shelves or compete online effectively could hurt its revenue growth trajectory.
It must also constantly stay on top of the latest trends or risk a decline in the popularity of its brands. The company acknowledges this risk in its 2023 10-K, which states:
The beauty industry is driven in part by fashion and beauty trends, which may shift quickly. Our continued success depends on our ability to anticipate, gauge and react in a timely and cost-effective manner to changes in consumer preferences for beauty products, consumer attitudes toward our industry and brands and where and how consumers shop for those products. We must continually work to develop, produce and market new products, maintain and enhance the recognition of our brands, maintain a favorable mix of products and develop our approach as to how and where we market and sell our products.
In other words, if a beauty trend shifts and ELF management fails to anticipate the change, its products could rapidly go out of style.
Valuation
ELF's price-to-sales (P/S) ratio is 11.67, well above its five-year median of 4.40, and the consumer staples sector's P/S ratio of 1.19. Some might consider the stock overvalued. Seeking Alpha Quant rates the valuation an F.
The charts below show why ELF's P/S ratio has exploded higher over the last two years. ELF's annual revenue growth at the end of FY 2024 reached 76.89%, far outclassing the revenue growth of peers like L'Oreal. With its current topline growth rates accelerating over the last several years, there is little wonder that the market is willing to award ELF a premium valuation.
However, if you believe analysts' revenue growth estimates, ELF's annual revenue growth estimates have peaked. Analysts expect annual revenue growth to drop to 25.57% this fiscal year. If growth decelerates rapidly, the market may not be willing to award a premium as high, and its P/S ratio may start moving back toward its five-year median.
ELF has a price-to-earnings P/E ratio of 93.50, well above its three-year median, a sign of potential overvaluation.
The following image shows analysts' EPS growth estimates for ELF and the forward P/E for the next three fiscal years. The forward P/E has exceeded the EPS growth rates in all three years, suggesting that the market may overvalue the stock. If ELF's FY 2026 forward P/E traded at its projected FY 2026 EPS growth rate, the stock price would be $109.35, close to a 50% decline from the June 20, 2024 closing price.
Let's do a reverse DCF to determine how much the company must grow FCF over the next ten years to justify today's stock price.
Reverse DCF
The second quarter of FY 2024 reported Free Cash Flow TTM (Trailing 12 months in millions)
$62 Terminal growth rate 3% Discount Rate 11% Years 1 - 10 growth rate 41.1% Stock Price (June 20, 2024 closing price) $209.23 Terminal FCF value $1.998 billion Discounted Terminal Value $8.794 billion FCF margin 6.1%
With consensus analyst revenue growth estimated at 19.78% over the next three years, a ten-year FCF growth rate of 41.1% doesn't look feasible. However, product manufacturers usually have 5-10% FCF margins. If ELF can reach an FCF margin of 10%, it would still need to grow FCF at 33.5% over the next ten years to justify the current price.
However, in a no-moat, trendy industry like the beauty industry, it is challenging to forecast what might happen two years ahead, much less ten, although some try. Analysts predict annual FCF to grow at a CAGR of 120% to reach $303 million by FY 2026. They also forecast an FCF margin of 19.96% in FY 2026. If the company trends toward growing FCF at a 120% rate over the next two years and the FCF margin rises near 20%, the stock may continue much higher over the next two years, despite some perceiving it as overvalued.
ELF is a Hold
It is easy to see why ELF bulls believe the stock can go much higher. The company is dominating its competitors and taking market share. If the company continues to execute, it could produce category-leading growth over the next several years and become the number one cosmetics and skincare company globally. If you are an aggressive long-term growth investor, you may want to be along for that ride.
However, if you are a conservative investor, now may not be the time to buy at the stock's current valuation. Wall Street analysts' consensus price target for ELF is $209.92, which doesn't leave much upside for the stock at current prices. Therefore, the risks may not be worth any potential rewards over the next year.
Investors who lack an understanding of the beauty industry may be impatient and quickly sell the stock if it declines in the short term due to growth or valuation concerns. I am giving ELF a Hold recommendation. The company next reports earnings on August 8, 2024. Investors should listen carefully to what management says about the current economic environment. Patient investors can buy this stock at a lower price if a slowing economy trips it up.
Star Investments
I have been a Merchant Seaman that has traveled the world for over 30 years. Within the last 15 years, I developed a very intense interest in investing. I learned a lot of what I know about investing from The Motley Fool. Also because I have a engineering background, I often tend to gravitate to Tech stocks
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
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