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Transcript : The Estée Lauder Companies Inc. Presents at Morgan Stanley Global Consumer & Retail Conference, Dec-07-2022 09:30 AM

07/12/2022 | 15:30

Presenter Speech
Dara Mohsenian (Analysts)

All right. Good morning, everyone. I'm Dara Mohsenian, Morgan Stanley's household products and beverage analyst. I'm very pleased to welcome Estée Lauder to the fireside chat today. Before we begin, a quick disclosure, please see the Morgan Stanley research website at www.morganstanley.com for our research disclosures, and you can reach out to your Morgan Stanley representative if you have any questions.

So joining us today, we have Fabrizio Freda, Estée Lauder's CEO, who's really been a key architect of Estée's transformation to a higher growth and higher-margin company. over the last decade or really over the last 13 years since you became CEO. And it's an interesting time right now, given the volatility in the industry to have Fabrizio here. So -- so it's great to have you here, and we appreciate you...

Presenter Speech
Fabrizio Freda (Executives)

Pleasure to be here. So good morning to everybody.

Question
Dara Mohsenian (Analysts)

I thought maybe first, there's obviously been a huge amount of volatility in the beauty category in Prestige Beauty over the last few years with COVID, but also a lot of other dynamics in terms of macro volatility at this point and commodity volatility, excess pricing, et cetera. I wanted to take a step back and talk about prestige category growth and your sort of viewpoint from a longer-term 5- to 10-year lens. -- after some of this volatility. It's too broad a subject. We might only have time for 1 question. So maybe I'll focus it in 2 areas, which is travel retail, number one, very high-growth, high-margin category and Estées had a lot of success there. Can you talk about the longer-term growth path from here and how you think about top line growth looking out longer term. But also it would be great to get an update with the development of Hainan, is that travel retail pie much bigger when we completely come out of COVID, looking out a few years? And how you think about the growth opportunity in travel retail from here with penetration already having increased quite a bit in the last few years. So an update there would be helpful.

Answer
Fabrizio Freda (Executives)

Sure. So first of all, again, good morning. In terms of the prestige category, the prestige category defined, we call it the actually prestige beauty. It has been in the last many years, a very high-growth category, even before speaking, the louder within the category. Obviously, we build market share within a growing category. That's been the driver of the strong growth. Now first part of the question, what is the future of that category overall?

I believe the future of this category will continue to be very exciting. This is a high-growth category. It's driven by middle class growth. There is 0.5 billion new middle class created between now and 2030, obviously, mainly in emerging markets, places like China, India, Brazil and others, but also in the United States and less, but also in Europe. And so it's driven with the class there is going to be middle class growth overall over the years. Second is growing a lot of consumption per capita around the world. Since we had an Investor Day in early '19, since then, to give you the -- an example of the consumption per capita of luxury beauty in the United States has been growing 18%, in places like India or Brazil, 40%, 30% and in China has doubled. And these are just a few years ago. And this trend is going to continue also because the habits in beauty are becoming more sophisticated. The regiments are more sophisticated.

This is not a category where the consumer men and women, by the way, not only women, where the consumer is just using 1 single product use a regimen. And this regime become more sophisticated, more thing. And the key driver increased sophistication is actually education. And that's the big difference between prestige and mass that the prestige brands educate. And we educate. We have a lot of resources in education. Education is category building, a category building allowed the big excellent brands to perform well.

Second, these industries by repeat rates. This is not a marketing industry. I know many women that try new products because there is exciting innovation, new ideas, new benefits beautiful brands. I still don't -- I don't meet 1 consumer that purchased this product the second time if the product is not working. And so this industry is completely by the repeat rates. We have in our brands, the highest repeat rates of the entire consumer industries. There are brands like, I don't know, Creme de la Mer repeat rates in the 60s on the target group. So this -- I mean when you have a 60% repeat rate, whatever you invest is an excellent payout. So you can also create trial and building. So that -- that's why I'm saying I'm very confident in the 5%, 6% overall growth in the market over the last many years has the potential to continue.

Now going to the second part of the question, what are the drivers of this growth for a company like us. Then travel retail definitely is one of the drivers. There are others. I want to say there is online that will continue to drive. There is definitely travel retail. What are all these channels there are growing channels that create new occasions for the consumer to engage with the brand. But the important thing to understand that the occasion is also an occasion to educate the consumers -- to create more understanding. It's not -- it's not a commodity business. It's a business where people interpret the use of this product. So the growing and winning channels tend to be channels where you just don't buy, but where you can educate. And I want just to clarify this historically, department stores were a great channel for us where it was because we're offering a superb model of education.

Now in today's world, they still are department stores offer a great model of education -- but this education, for example, is also possible online, thanks to technology. Today, you can go to a brand.com, get a chat, get people talking to you and get live streaming and get try on products. So a lot of the world of education and engagement have been transferred also in other channels, which tend to be, in many cases, more efficient and so more profitable for the company. So overall, the channel dynamic of the entire industry has become more attractive in terms of profitability globally.

Now at the center of this channel attractiveness, there is travel retail. And travel retail, first of all, COVID obviously was disrupt in travel retail probably more than any other channel. And so we are in a recovery phase. First of all, travel retail is, in this moment, is recovering in Europe in an incredible way. Airports are full. Our business is accelerating, is recovering in the Americas. So the first information is that when travel comes back, travel retail channel comes back in a very strong way, and that's clear. In this moment, the biggest travelers the buy -- to be clear, we have a very clear analysis that certain travelers buy more than others. For example, American travels buy less in travel retail than Chinese travelers or Indian travelers, or Middle Eastern travelers or even European does. So every traveler has more preferred moments of engaging with buying tourists, some tourist travel to go to a beach, some tourist travel to buy and to have a purchasing as entertainment. It's part of the game of entertainment. So different population, a different prioritization of what they do when they travel.

That's why travel retail business needs to be global, and you need to manage what we call the corridors of certain consumers. The other thing is important to understand that travel retail is reflecting the perception of the brands in the country of origin where the traveler comes from. So to win with travel in China, you need to win in China. To win with traveling people from India, you need to win in India. So it's not only being strong at the destination is to be strong on the origin. That's why travel retail is one of the channels where the concentration of global brands of global companies, of great companies with great portfolio of luxury brands is more important than in any other channel, any more successful, frankly, than in any other channels.

So great channel, which is in a recovery mode from COVID, obviously, not yet in China with the Chinese consumer, which is the key topic because they are one of the biggest travelers. So part of the question was what's happening with Hainan, Hainan has been an extraordinary creation of a new channel because as you can imagine, in 2019, before the start of COVID, the numbers -- public numbers says there were about 60 million Chinese that travel the world for tourism. And this number was growing every year, then this went to basically almost 0. And in Hainan, till January, February of this year, so before COVID impacted also Hainan, they were on a yearly basis, 120 million visitors. This was created in 2, 3 years during COVID.

So basically, they doubled. And that's why you have seen all of a sudden, during COVID some extraordinary performance. You have seen that, I don't know, we have at business in Hainan that was more than offset in the fact that Europe in total was -- Europe and U.S. were completely closed. We could do more in one place because there were 120 million people versus 60 million traveling before. So it's been an extraordinary acceleration. And that's what has made TR continue to be an exciting channel even in the middle of COVID disruption. Then obviously, COVID impacted exactly Hainan and exactly China now is going gradually a bit better. But as you know, there's been the critical issues of the last months. And so in this moment, it's been less efficient, but I believe we'll come back as soon as the COVID policy in China will evolve positively. Hainan will come back.

It's an extraordinary place. I don't know if you have been there just before COVID because in the last year, you probably cannot have been there. But in the -- before COVID is an extraordinary place. There are the most beautiful stores of the world in luxury. There is incredible entertainment that are amazing beaches with beautiful surf schools on every beach is there are the best medical -- best hospitals in the country. There are great surgery possibilities. There are the house of the wealthy people in the country. That has basically become the typical high-end vacation place that is in many countries of the world that is serving the local today in a COVID situation. I believe, in the future will serve also international travelers because it's an interesting place to visit. So Hainan is today strong with Chinese, obviously, will become much stronger after the COVID will be managed. And then 1 day, we'll have also international travel, particularly Asian travelers like many others. So this is going to continue to grow.

Second, the Chinese probably start in 2024 if we believe the public information that we got will start traveling internationally again. And this is the change of the travel retail acceleration because, as I said, they are the most numerous travelers, and they are very high -- very interesting purchasing because in their travel buying is part of the entertainment, part of the pleasure. And so this will happen, probably start 2024. This will be another big acceleration. Will this cannibalize Hainan, sometimes I get the question, maybe in little part, but again, keep in mind, 60 million, 120 million. the travelers internationally come mainly from Tier 1 and Tier 2 cities. The traveler to Hainan is mainly from Tier 3 and Tier 4 cities. They have different costs, obviously, different pricing lags or travel internationally to Paris or traveling to Hainan. So target to different groups of population, different groups of middle class. So there -- obviously, there will be some cannibalization not a lot. So at the end, a lot of what Hainan created will be in the future, a net extra that was what was travel retail before. So very, very exciting.

And the last thing I want to say travel retail is an incredible trial vehicle. So we have the numbers. We have a lot of numbers on consumers that explain that many consumers buy the first time our brands in travel retail. So travel retail is a trial build is very efficient because it's profitable. So it's a very efficient way to build trial for our brands. And so it's also a business builder, not only business leverage. And last thing is travel retail is driven not only by traffic, which is what I commented so far is driven by conversion. What I mean is what is the number of travelers that buy anything. Now before COVID, this number for our industry was around 15%. As I said, very different by population and corridor. That was around 15%, meaning 15% of the travelers will buy anything in beauty in travel retail.

Now what happened in the recent year, particularly in Asia, this being created this methodology, it's called pretail, Basically, you -- if you have a ticket for traveling, you go online, you buy online with your travel ticket before going to Europe maybe the evening before you travel. Now when this possibility retailing is available, we see conversion even doubling. So now we imagine the future technology to bring pretailing possibility, not only today is Korea, China mainly, but to the rest of the world, and this will happen gradually over time. So imagine then conversion to start increasing and maybe not doubling everywhere, but the 15% in the post-COVID world, imagine this to be 25%. So imagine to have new traffic growth plus a doubling of the business of conversion. So the opportunity is really, really big. It's probably one of the biggest channel of opportunity. If you add to this, the channel structurally is profitable and is in our case, accretive to the average of the company. This is -- remains -- it's not new, but remains a very big opportunity for long term. And when you add what I was giving you in terms of consumer insights, that is image building because they are beautiful. Many airports are beautiful. Hainan is beautiful. So deliver the aesthetics of luxury, if you imagine to deliver also the services of education that I was saying would be one of the biggest drivers of the category because there is space for consult and counters, beautiful people at time, imagine how much time we spend in airports now that we are happy to be entertained and been educated. So there are all the conditions also to serve brand -- sorry, I spoke about trial. There are all the conditions to be not only a beautiful channel, but to be a brand-building opportunities for the brand will be able to be there.

Question
Dara Mohsenian (Analysts)

Great. That's helpful. The other key channel that really has had great growth for you guys over the last decade has been e-commerce. Obviously, [indiscernible] travel retail during COVID, travel retail compressed, e-com structurally accelerated. And in a lot of countries like China, in particular, right? You've really seen a big ramp-up in penetration among consumers being online over the last 5, 10 years. How do you think about e-commerce as a growth vehicle going forward? How much of those incremental customers were you able to hold on to during COVID? And when you think about the longer-term growth path from here, give us some perspective, again, particularly versus that penetration already having risen so much over the last decade and maybe there's not as much opportunity for incremental consumer penetration online?

Answer
Fabrizio Freda (Executives)

Yes. First of all, I want to say that our best businesses are when we have omnichannel opportunities. So -- what I mean is that an ideal situation has both brick-and-mortar and online. So the penetration of online in, we believe, will continue to grow. But at the end, we need both. And where there is the combination of the balance between the 2 is the best thing for the consumer, it's the best thing for the business and also allow us to synergize between the 2 and so create the right cost structure. So there is no word only online, there is no word only brick-and-mortar anymore. The question is, what's the balance and what is the opportunity for online to increase penetration.

Now first of all, during COVID, as you all know, the penetration of the line increased enormously. Now is this sustainable? Yes, in my opinion, it's completely sustainable because when you go to the next level of information for us, for our brand, now I can speak for our industry and for our brand, the young people, relatively younger consumers were already online before COVID.

So what happened during COVID in the young people, they increased their level of exclusivity online. But they were already very familiar. They were buying online 60% of their needs, they went to 90% of their needs. So increased penetration did increase exclusivity, sorry, didn't increase penetration. But the people of my age they were for the first time online. And the 50-plus in our industry, people started buying online. They went from 5% online to 100% online because in the case of more senior people actually during COVID, they were more concerned than the young people. So they were actually more exclusive online.

And this is now coming back because this population has learned how to buy online. And we see it now they still continue. The very way, they're super happy to be back to brick-and-mortar when brick-and-mortar reopen, still continue to buy also online. They may have changed now the exclusivity level from 100% to a certain proportion. So that's what's happening. So penetration of online has increased and has increased forever and will be there. The game will be exclusivity. So how much every consumer will be exclusive to one channel or to the other? We don't see any more a lot of exclusive consumer to one or the other. It's going to be a balance. And so which percentage your business in one and the other channel.

So with that in mind, online will continue to be -- for us, is the other accretive channel because it's very efficient. And so we'll continue to be an extraordinary channel. We'll continue to be a channel that is increasing penetration gradually however, not like COVID was a big punch, but gradually increasing. Why? Because despite what I just explained that every age group is now buying online, despite that, the younger age group is buying online with clearly higher exclusivity. And so when you imagine that the 20 to 30 years old today will be 30 to 40 and the 40 will be 50. When you imagine the evolution of the population, you just see an increased exclusivity online going with demographic. So it's as simple as that.

And unless you assume that when you are 20, you are more exclusive online than when you will be 40. I don't think so because, at the end, it's a matter of comfort personal habit, experience definitely, when I look at my children, I don't think so versus me because they are natural and -- and I need to make an effort even to explain it to you, but let alone to use it every day. And so there is a generational shift, which is clearly happening. And this generational shift is in favor of gradually increasing penetration online.

The other thing that is so important online is the education, I was speaking before. Remember, in our industry, the ability to educate the consumer is key. Now online technologies are allowing try-on products that were only possible in stores before with the methodology of the photograph, is a long live streaming. So basically speaking with people that tell you about how to use the product, it's a chart with consult. And if you go to our clinique.com, you can speak to the same white coat before you could only find in store, is allowing other kind of experience, even on a promotional basis to meet your preferred celebrity or [indiscernible]. So the world of online driven by technology is becoming much richer, not only of product buying in a convenient way, which is where online comes from but of experience, which was before only possible in store. And now the experience is also possible online.

So with this gradual evolution, driven by technology, the penetration will continue to increase and the exclusivity of certain groups will continue to increase. So we view online as a big opportunity for the brands of the company. We'll continue to drive it. We'll continue to invest in services online. We'll continue to drive our brand.com and drive the other channel.

The other thing which is happening, maybe I should comment briefly is that online is not one block, it's different channels. And now we have learned how to -- what is the best methodology in every channel. There is the brand.com, which is for us direct to consumer. No, we have -- between freestanding stores and brand.com, now we have omnichannel technology where the consumer -- we have a full view of the consumer and the consumer a full view of the opportunity to buy. Then there is the retail.com. Obviously, that we do with all our key retailers. Then there are the platforms like Tmall, which is increasing penetration and all over the world.

For example, we have supported Tmall when they purchased Lazada in Southeast Asia to bring the Tmall model to Lazada, meaning the stores where we control everything, retail, price, et cetera. And it's basically -- that's why it's called Tmall for the one of you -- they're not very familiar with it because it's like a mall. Well, you have your freestanding store of your brand in this mall, they're responsible of bringing you the traffic. You do all the rest. So it's a beautiful model for luxury. And we are expanding that model in many other emerging markets in many other places. And then there are the pure play. So people that, for example, like, I don't know, [indiscernible] people that have been building a business on fashion and they're adding beauty, which is the same thing in the past, department store or other people will do that is also happening. So online is now becoming different channels building, in each one of these channels, we are building unique expertise and methodology to win for the long term. So very promising and definitely a long-term opportunity.

Question
Dara Mohsenian (Analysts)

Great. That's helpful. Maybe shifting off the business for a minute, and this is a little more of a sensitive subject, but hopefully, a fair one. I talked about in the introduction, the tremendous shareholder value you've driven in your 13 years as CEO. But there's always a question of transition, right? And when there might be the next CEO, given that shareholder value driven, particularly given some retirements of more senior executives. I'm sure you guys have been developing. There are successors behind that. But it's a question that comes up among investors. So a, I guess, just your personal level of commitment to the CEO role and how you think about that in terms of longevity and whatever way you feel comfortable answering? But then b, sort of working with the board on succession planning give us a little bit of insight into that, whatever sort of appropriate in your mind, it would be helpful to hear your view on that subject.

Answer
Fabrizio Freda (Executives)

Thank you. I hope you can -- this question comes from the Hope that I stay more.

Question
Dara Mohsenian (Analysts)

Yes. That's very clear. We're not trying to go over to you.

Answer
Fabrizio Freda (Executives)

And -- but let me know if I have a different point of view, but is frankly, the short answer, I'm completely committed to continue leading this company for the foreseeable future. And there is no plan from my angle to enter a transition period. We are in -- by the way, in the middle of a big business transition out there. There is a lot of evolution issues around the world is one that we are managing. As I was explaining, I hope you recognize that what I was describing are extraordinary opportunities for the future that this company has in the sense, our company is now navigating a tough external environment, well, I believe, given the gigantic issues out there and the way demonstrating how much strong the company is even in presence of purpose external storms and is ready to recover as these storms goes down and reaccelerate in the future and is even more opportunity in my opinion in front of us in the long term. So it's a very exciting moment but also a very important moment. And I'm completely committed to this company. I believe we have created one of the best companies in consumer goods with extraordinary opportunity for the future. This is part of me. So I don't know if you see that. I don't have any second thought or what else I would like to do. I'm doing that. So there is my full commitment to that.

The Board of Directors is the one really decided. So my comment is only part of the story. And as far as I know today, the Board is with me, and we are committed to continue working together. So we are not entering today a transition period.

However, we are definitely managing success in the core way. And so out of the succession is a different methodology than just CEO succession. I personally don't believe in CEO succession at least for our company, the way we build it as the only thing. I need a succession model for the team because at the end, we are not the kind of company where the day in which there will be a transition of the CEO. I don't know, will be a new CEO, a new team and a new direction. Now this is a long-term strategy where we have a continuity. As you said, we have changed the direction of the company and there is so much still to do in this area, which is fascinating. So we are looking for a succession that includes the team. And in fact, I work with the Board on a program that we call the team of the future. We don't call it only CEO succession. It's about repairing a team that will continue to lead the company.

That brings me to the recent retirement and the other thing. To be very clear, this is a known issue in the sense this retirement were retirement and the way are planned for years. I knew each one of them since a very long period of time, and we have developed the people that will take this position for taking this position. And on top of this, there are 2 or 3 layers below that we continue to develop as the team of the future. And so in every single function, every single new capabilities, we develop people. Many of the people that now are in this position of leadership, for example, our leader of international Cedric Prouvé decided to retire and Peter Jueptner in this position. Now Peter has been prepared for this position for years. It was my partner on strategy. For some time, he built the strategy of the company. With me, then I wanted him to have a super commercial experience that he needed and he went -- has been the leader of EMEA. EMEA has been one of the best market share growing part of our business.

And then when Cedric announced to me well in time what was his life intention, we prepared this then Peter entered. And I can tell you every single of the retirement, you have seen a part of the planning and is a part of a planning, not only auto to put extraordinary well-prepared leaders in every position, but also of the planning to keep the team together for the culture of collaboration. Today, we are an extraordinary team. And I'm going to show to investors which are interested more and more of the team in the future years. We are an extra ordinary team that can finish each other words that we working together. The company is now built with a backbone, which I call the strategic process. The start from the Compass, which is the 10-year vision, goes to the strategy with all the financial numbers in the next 3 years, goes to the budget process like any other company. And this process then goes to every brand strategy, a very regional strategy, every functional strategy aligned to the total strategy. And I'm a little bit the cast Director of this process. This process happen every year on a rolling model. This process is amazing not only because it make us allocate resources in the correct way over time and making the changes of direction in time before the changes hit us.

On top of that, this process is precious because brings the team together. They do this process together. They learn from each other, they can finish each other word, somebody which is working in Australia can know exactly what the brand is doing in New York because they connect via this process every day. So this model of a very collaborative united team with a common vision, common strategy and different executional expertise that collaborate is the company we've built. The succession process needs not only one day to have the right view and the right transition process, but to make sure that this culture, which is behind the strength of this company is maintain, retained and developed for the long term. And so that's what we do with the Board. That's what I spend a lot of time on. And so it's a different concept of CEO succession plan, more articulated.

And frankly, so far, from my angle, very successful because I'm super happy with the team I have today. If anything, even happier where we were a year ago or where we were 2 years ago, we keep improving. And we don't have any short transition in this moment in the company.

Question
Dara Mohsenian (Analysts)

Great. That's very helpful. Well, we hope you're here for many years to come, and I hope you join me on stage personally also over the next few years. for many years to come. We've got one minute left, but I can barely ask a question in a minute, and I know you probably can't answer a question especially with my broad-based question.

Answer
Fabrizio Freda (Executives)

Give me 30 seconds. I'll use 30 seconds.

Question
Dara Mohsenian (Analysts)

I think one thing there. Thank you very much for joining us. We appreciate it. And as always, very informative.

Answer
Fabrizio Freda (Executives)

Thank you very much. Thank you.

Question
Dara Mohsenian (Analysts)

Thank you very much.

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