e.l.f. - Beauty In The Eye Of The Beholder

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Summary

e.l.f. Beauty (ELF) reported fourth quarter results which were welcomed by investors in what is a very tough operating environment for obvious reasons of course.

The last view on the shares dates back late summer 2018 as I concluded: "e.l.f. Beauty: not so pretty", with shares dropping from about $15 towards the $10 mark at the time upon the release of soft quarterly results. Shares have rebounded as the company has seen continued growth, driven by a sound positioning, yet valuation multiples are too high to leave appeal from here.

The Business, The Thesis

After the company went public late 2016 I was cautious on the buzz created around the new beauty brand with shares trading at a premium valuation around $25-$30 per share.

The promise of e.l.f. is simply seen in its name, as the name stands for eyes, lips & face. The promise of the company was to sell beauty products at accessible prices, typically retailing at $6 or less, creating demand and momentum with millennials.

Originally a pure-play on e-commerce, the company has grown into the retail channel. This is not just driven by its positioning, yet results from focus on innovation, rapid development of products and social media traction as well.

Ahead of the IPO late 2016, I noted that the company has seen some momentum. The company reported a 32% increase in sales in 2015 to $191 million, accompanied by 13% operating margins. Revenues grew another 20% to $230 million in 2016, with margins compressing to 10%. The 2017 results were pretty resilient with sales up 17% to $268 million and margins improving to 12%. Based on that margin potential, the capital structure and 50 million shares outstanding, I pegged realistic earnings at around $0.40 per share that year. This translated into very high multiples as shares hit the $30 mark following its IPO, and still traded in the $20s in 2017.

When I looked at the shares in August 2018 shares had fallen from $15 to $11 per share. Sales growth slowed down to mid single digits and margins were under pressure, yet with realistic earnings power just below half a dollar per share, valuation multiples were still high. Nonetheless, I saw a silver lining, including that of an interesting brand, and hence I initiated a small speculative position around $10 a week later.

What Happened?

In 2019 the company announced a change in its fiscal year, which makes it hard to make a real comparison. In early 2020, e.l.f. announced a small acquisition, a $27 million purchase of W3LL People and in May the company announced its fiscal 2020 results.

Full year sales were up 6% to $283 million yet that was despite 22 own stores being closed during the year, a move which cut sales by about $12 million, or about 5%. The company reported flattish adjusted EBITDA at $62 million, with net debt of $92 million translating into a reasonable leverage ratio of 1.5 times.

E.l.f. furthermore reported flattish adjusted net income of $32 million, equal to about $0.63 per share. This is of course highly misleading as it excludes about $15 million in stock-based compensation, as adjusting for this real expense, realistic earnings come in just half that level, or about $0.30 per share.

With sales having regained some momentum, driven by market share gains, the company has seen shares increase towards the $20 mark early this year. Shares plunged to just $8 and change during the Covid-19 crisis, before rebounding to $17.

Part of that recovery has been driven by the resilient results in the final quarter, ending March of this year. This makes that the numbers include about a month of the Covid-19 crisis. The reported 13% sales growth and even 16% sales growth excluding the impact of own store closures makes investors upbeat, as that is simply very impressive.

Some other silver linings is that of obtaining more shelf space at Walmart (WMT) and the fact that the pricing makes it look attractive in this environment versus premium plays.

Cashing Out

Despite the upbeat conclusions above, the conference call sheds some further light. The industry saw sales declines of 30% in April and even high single digits declines in May despite stimulus checks coming in, as based on realistic earnings power of $0.30 per share (with the question being if this will be achieved again this coming year), makes that shares trade at about 50 times realistic earnings.

Hence, having made a nice 60% return in less than two years, while the company has not lived up to its promises and the current environment is far from friendly to unleash the potential of the business, I am happy to take the profits on what has been unfortunately a too small position.

While strong traction with great performing retailers like Target and Walmart and focus on price will both certainly help in this environment, it should still only mitigate the headwinds.

Nonetheless, e.l.f. remains an interesting emerging brand, company and stock to keep track of, certainly as its margins are below that of its peers and the company continues to grab more market share. Hence, I will continue to keep track on the developments from here onward, yet at current levels feel no urge to longer hold a position here.

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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.