e.l.f Beauty (ELF 12.86, +1.76, +15.86%) is trading higher today after reporting
Q3 earnings last night. The company’s mission is to make “luxurious beauty
accessible for all.” Walmart (WMT) and Target (TGT) accounted for 29% and 25% ,
of sales in 2017, respectively. Ulta Beauty (ULTA) is another key retail
e.l.f. offers beauty products for eyes, lips and face (that's where the e.l.f. name comes from), with the majority of its items retailing for $6 or less. Its price points encourage trial and experimentation. ELF also has strong appeal with Millennials and Hispanics, two of the fastest growing demographic groups in the US. As a result, e.l.f Beauty is one of the fastest growing cosmetics companies in the US. There is a gap between high-priced prestige beauty products and less innovative mass products. ELF feels that it fills this gap by offering prestige-type products at value prices.
Q3 Analysis: Turning to the Q3 results, non-GAAP EPS fell to $0.17 from $0.20 last year, but that was much better than market expectations. Revenue fell 11.1% yr/yr to $63.9 mln, which was also better than expected. ELF also slightly raised the lower end of FY18 non-GAAP EPS guidance to $0.59-0.61 from $0.56-0.61.
While it's nice to see today's pop higher, one look at the stock price over the past year and you can understand why investors have been frustrated. After hitting a high near $24 in December 2017, the stock has been steadily declining and closed yesterday in the $11 area following a series of disappointing earnings results.
In September 2018, an activist hedge fund, Marathon Partners, wrote a letter to the company urging them to refocus on core operations by ceasing evaluation of acquisition targets, reduce and optimize its high-cost structure (including executive compensation) to fund brand investment, boost margins, and grow profits. The firm feels the e.l.f. brand is carrying a great burden, covering all of the overhead of a platform designed to support multiple brands as well as an extremely generous compensation plan for senior executives. If this isn’t viable Marathon Partners suggests considering a sale of the company.
So far, ELF has been telling them no thanks. ELF does have a plan to turn the business around. Its first focus is investing more behind the brand. ELF has been spending around 3% of sales on marketing, but that is going to increase so that the brand can break through in a noisy marketplace. ELF will provide an update in early 2019. The second pillar is ELF's plan to put greater focus on key items. For example, in Q3, ELF put an integrated effort behind Beauty Shield Magnetic Mask. This $24 product is a great example of ELF's high quality but good value proposition as the only other thing like it in the market is a $75 Prestige product.
The final pillar is getting optimal assortment at retail. A major 2019 initiative that should help improve productivity at retail is Project Unicorn. This is a major product, package and shelf initiative that elevates brand presentation and improves navigation. ELF has been planning this initiative since 2017. Project Unicorn eliminates and changes the outer packaging on select SKUs.
In sum, this stock has been struggling so it's good to see a good report. ELF made its IPO debut in September 2016. By early December 2016, it was trading north of $32. However, it has been in a steady decline since then. However, we think there is long term potential here as we really like the niche ELF serves, somewhere between prestige and mass market cosmetics. Today's big move is probably partly due to short covering, but hopefully it's a precursor for a strong Q4 holiday report.
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