elf Beauty’s ‘Beauty Team’ Increases Market Penetration Globally (NYSE:ELF)

Introduction and investment thesis

Last time I wrote about elf (NYSE: ELF) in June, where I reiterated my “buy” rating on the grounds that there is plenty of white space in the company’s cosmetics and skin care category as it drives robust product innovation at compelling prices with buzzworthy marketing to attract and retain its users both digitally and in its US and international retail locations. Although the stock was initially up, it has since fallen over 17% from my publication price.

The company reported its Q1 FY25 earnings in early August, where revenue and adjusted EBITDA rose 50% and 4% respectively from last year, beating estimates as it continued to gain market share for its segments of cosmetics and skin care in its US and international markets in an environment where its competitors have seen overall declines. At the same time, management raised their full-year revenue and earnings guidance for FY25. While revenue growth is expected to slow given the difficult mix as well as tight consumer budgets, I continue to remain bullish on the company, as its compelling pricing and product innovation should enable it to capture market share as it successfully engages its audience both digitally and digitally. in retail locations, leading to higher average order values ​​and purchase frequency. Rating both “good” and “poor”, I will reiterate my “buy” rating with a price target of $233.

Advantages: superior performance in color cosmetics, skin care and international sales as elf takes market share

elf Beauty reported Q1 2025 revenue, which saw revenue grow 50% year-over-year to $324.5 million, driven by continued strength in its color cosmetics, skin care and international trade businesses digital and digital commerce, with enrollment in the Beauty Squad loyalty program. 30% YoY, where these members tend to have higher average order values, purchase frequency and strong retention rates.

In the first quarter, color cosmetics grew 26% year-over-year, increasing its market share by 260 basis points to 12%, with management remaining optimistic that it can double its market share over the next few years, on as it replicates its successful Target (NYSE:TGT) ) manually for other retailers. I’d also like to point out that Elf’s color cosmetics performed better at a time when the overall category was down 1%.

Meanwhile, its skin care segment also continued to surpass 45% growth over last year, increasing its market share by 60 basis points to 2% and leading elf SKIN to be a brand top 10 for the first time. Similar to color cosmetics, the company’s skin care segment outperformed the overall category by 32 times, which I think is pretty impressive, with management attributing about 16 points to the net sales growth from Naturium in Q1. With the number one brand holding 14% market share, elf management believes there is plenty of room for growth in the coming years.

Finally, when it comes to its international segment, the company saw 91% growth over last year, contributing 16% of total sales, up from 13% a year ago, as it partnered with retailers of leading beauty brands to position their brands in each of their international markets where they are expanding while driving engagement on social platforms to attract and convert users. Management highlighted the UK and Canada as examples where they are now the number four brand, up from number eight and six respectively a year ago.

I believe elf Beauty’s performance can be directly linked to a combination of its value proposition, product innovation, marketing engine and productivity model. The company has seen its quality scores increase every year for the past five years as it continues to deliver quality products at affordable prices, resulting in strong unit growth.

Meanwhile, their product innovation is centered on gathering inspiration from their community as they build successful franchises to gain market share. One of the markets elf is looking to expand into is foundation, where they launched their Soft Glam Satin Foundation in Q1 at $8, compared to a $39 prestige item, making the product one of the best sold during the quarter. At the same time, elf continues to generate culturally and emotionally resonant marketing content with their recently released bronzer drops, which have become the best launch product on the site, along with building an elf up experience on Roblox to enter in relation to the GenZ and Alpha audiences, thus generally growing unaided. brand awareness from 13% in 2020 to 33% in 2024. In combination with a strong value proposition, product innovation and marketing engine, the company also uses information from its website and loyalty program Beauty Squad to maximize average sales per SKU while gaining shelf life. space among retailers such as Target, CVS (NYSE:CVS), Ulta Beauty (NASDAQ:ULTA) in the US, as well as Shoppers Drug Mart in Canada, Superdrug in the UK, Rossmann in Germany and more.

The bad: Profit margins narrowed year-on-year, while inventory levels rose amid fears of a macroeconomic slowdown

Although elf saw an 80 basis point improvement in its gross margins year-over-year to 71% as it benefited from a favorable foreign exchange environment, lower freight costs and higher ASPs in international markets, the margin its Adjusted EBITDA fell from 34% last year to 24% as VGA expenses increased to 51% of sales compared to 39% last year, with marketing and digital investments increasing to 23% of total sales compared by 16% last year.

However, management stressed that these were planned investments and expects adjusted EBITDA growth to accelerate in the back half of FY25 as they cycle through the inclusion of Naturium in the financial statements and see normalized rates of marketing investment of from year to year. Meanwhile, their ending inventory also increased from $98 million to $200 million year over year. While part of the reason for the stockpile build-up is related to higher consumer demand, I think investors are cautious in an environment where consumers are increasingly financially strapped after one of the longest periods of interest rates high interest rates, leading to record credit card debt.

In addition, Ulta Beauty cut its full-year guidance in its most recent earnings call after reporting a comparable sales decline driven by a decline in transaction volume and average ticket size. This indicates that consumers are indeed cutting back on spending on beauty products for now, which will hurt elf’s robust top-line growth rates and its market gains. However, I think management is aware of this, along with the tough comps on the way, and as a result, its full-year revenue guidance for FY25 sees a normalization of growth rates from current levels to the high range of 20 years. On that note, management raised its revenue and earnings guidance by 4 percentage points from its previous estimate to approximately $1.29 billion with adjusted EBITDA of $299 million, representing management’s confidence to continue to capture market share market with a focus on operational efficiency in an environment where established brands such as Maybelline, L’Oréal, Covergirl, Revlon and others may face pressure from competitive pricing and product innovation from a price-sensitive customer .

Revision of my rating: The top remains intact.

Taking into account management’s revised revenue and earnings estimates and assuming the company can maintain its high-teens revenue growth rate over the next two years as it gains market share in its cosmetics and skin care segments through innovation rapid product launch and memorable marketing moments, thereby driving higher AOV and purchase frequency in both the US and international markets, should generate nearly $1.8 billion in revenue by FY27. profitability, assuming the company can gain 100 basis points of margin each year over the next 2 years as it streamlines its SG&A spend toward targeted investments, as well as benefits from operating leverage from growing members of the Beauty Squad loyalty program , should generate nearly $449 million in adjusted EBITDA, which will equate to a present value of $385 million when discounted at 8%.

Using the S&P 500 as a proxy, where its companies grow earnings by an average of 8% over a 10-year period, with a price-to-earnings ratio of 15-18, I think it should trade at least 2x multiple given. the growth rate of its earnings during this time period. This will translate to a PE ratio of 34 with a price target of $233, which is a 55% upside from current levels.

My final verdict and conclusion

Despite the fact that the stock is down more than 17% since my last “buy” rating, I continue to remain bullish. While the overall macroeconomic environment could worsen in the short term, with Ulta Beauty sounding the alarm in its latest earnings call, I think elf Beauty’s FY25 earnings guidance has already factored in the risk. Additionally, I believe that elf Beauty’s compelling pricing and robust product innovation will enable it to maintain and gain competitive positioning relative to its peers in the coming years, where it sees market share gains as it is able to capture audience successfully. with resonant marketing moments translated into strong performance in its retail stores as well as enrollment in its loyalty program. While I will monitor its stock levels and profit margins trend in the coming quarters, I believe the stock is attractively priced to generate significant long-term returns, thus reiterating my “buy” rating with a $233 price target.