The Long and Short

Estee Lauder’s brand review appears credit neutral

| January 31, 2025

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Estee Lauder (EL: A2/A*-) recently announced that it had asked Evercore to help review its portfolio of brands, indicating the company could be planning to sell brands that new management sees as non-core. The news comes as the company is working to reduce leverage from acquisitions over the past two years that put stress on credit metrics. While it is difficult to project results, management’s demonstrated commitment to improving the balance sheet in recent quarters indicates that the company would likely proceed in a manner that preserves good credit metrics. Current valuation of EL bonds appears to already reflect the risk of lower ratings if progress stalls. Therefore, there is potential upside in the name if credit holds or improves.

EL traditionally maintains extremely conservative credit metrics. In April of 2023, the company closed on its $2.25 billion acquisition of Tom Ford, adding significantly to balance sheet leverage, but also adding a core premium brand to facilitate growth. EL had previous arrangements to license, but the acquisition gave them total control of the brand. Not long after, the company picked up DECIEM for $860 million in an all-cash transaction. Debt-to-EBITDA rose over 3% with the purchases and peaked late last year at a level of 3.8x.

The rating agencies have afforded EL flexibility to get leverage back under the 3.0x threshold in order to maintain mid-A ratings. However, S&P expressed skepticism by placing the ratings on review for downgrade in late October of last year, after the company had pulled their 2025 guidance. Meanwhile, Moody’s has maintained a negative outlook on the ratings but seems more inclined to wait and allow the company the necessary time to work down leverage. However, even if both rating agencies were to downgrade EL’s ratings, the company would stay in the single-A category and these scenarios already seem to be priced in (Exhibit 1).

EL recently appointed a new CEO and CFO in early 2025 and late 2024, respectively. In order to address the weakness in the balance sheet and preserve cash for deleveraging, the company has suspended share repurchases and cut dividends by 50%. Management further demonstrated its commitment to the balance sheet when it paid down a $500 million debt maturity in December of last year from cash on hand, rather than issue additional debt.

The recently announced plans to consider brand sales appear rooted in the company’s desire to keep shareholders satisfied while they continue to make inroads in improving credit metrics. There is no way to know what brands would be on the block, nor does the company break out their revenue and earnings by brand making it difficult to what the impact would be even there was a strong opinion on which brands may go. Tom Ford and DECEIM seem unlikely to be at risk. The company breaks down its revenue by product type. They generate 50% through skin care, 29% through makeup, 16% through fragrance, and 4% through hair care.

Exhibit 1. EL vs Consumer Products peer group (BBB+ and higher ratings)

Source: Santander US Capital Markets LLC, Bloomberg/TRACE G-spread indications

Helping mitigate the pressure from shareholders to divert cash received from potential brand sales to shareholders, as opposed to balance sheet improvement, is the extent to which EL remains a closely held company. The Lauder family holds a 35% ownership stake in the company and 84% voting stake, with four of EL’s 16 board directors. This should help limit the ability of activist shareholders to establish positions to enforce change that might be to the detriment of bondholders. It seems more likely that potential debt reduction with the proceeds from brand sales would be commensurate with lost revenue/cash flows, or in other words a credit neutral event, particularly given management’s proven willingness to put shareholder remuneration on hold.

Underlying EL’s ability to weather the current challenges is the company’s extremely robust liquidity profile. EL had approximately $2.35 billion in cash on the balance sheet (prior to the December debt maturity), plus an additional $2.5 billion credit revolver through 2025. The next public debt maturity is $500 million due in 2027. Meanwhile, despite a weak operating environment over the past year, EL generated $1.3 billion in free cash flow in the trailing twelve months as of end of September, 2024.

Other noteworthy factors worth mentioning include the residual litigation risk related to talcum products contaminated with asbestos, but those concerns appear manageable. EL took a modest $159 million charge in the last quarter, which is expected to cover 70% of the outstanding claims against the company. Also worth mentioning is the Company’s increasing reliance on China with Asia/Pacific making up 31% of annual net sales, and the region making up a growing percentage of overall business, particularly for travel retail. With protective US tariffs a hot button issue for the new administration, the prospect of an escalating trade war with China remains a legitimate concern to EL’s operations over the near-to-intermediate term. Retaliatory tariffs in the region could have a direct impact to operations and cash flows.

Dan Bruzzo, CFA
dan.bruzzo@santander.us
1 (646) 776-7749

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