e.l.f. Beauty: There’s Further Room For Upside In This Growth Story (NYSE:ELF)

Introduction & Investment Thesis

e.l.f. Beauty (NYSE:ELF) is a multi-brand beauty company that offers premium-quality cosmetics and skincare products at compelling price points compared to its competitors. I initiated a “buy” rating on the stock on April 5th, where my thesis was predicated on my belief that the company is positioned to gain market share in its cosmetics and skincare products, as it drives robust product innovation and buzzworthy marketing to engage and convert users across its digital and retail ecosystems. Since then, the stock has outperformed the S&P 500, growing 11.7%.

The company reported its Q4 FY24 earnings on May 22nd, where its revenues and earnings grew 77% and 100% YoY for the full year, respectively, exceeding expectations, as it gained market share in its Cosmetics and Skincare products to 10.5% and 1.6%, respectively. For FY25, the management has guided revenue to grow at 21% with an Adjusted EBITDA margin of 23%. While this marks a slowdown from its FY24 levels, I am impressed by the company’s go-to-market and product innovation strategies as it looks to expand its space across retail locations in the US and internationally, while it builds durable product franchises to drive engagement and customer spend.

Although I am slightly concerned with a possible shrinking of ROI on marketing spend in FY25, especially in the event of a macroeconomic slowdown giving rise to margin pressures, I believe that the stock is attractively priced given the risk-reward, making it a “buy”.

The good: Accelerating market-share growth in Cosmetics and Skincare, while it expands internationally, along with robust digital and retail go-to-market strategies and continuous product innovation

e.l.f. Beauty reported its Q4 FY24 earnings, where revenue grew 77% YoY to $1.02B for the full year, with Q4 marking the 21st consecutive quarter of market share gains as they outperformed across their three pillars that include Color Cosmetics, Skincare and International expansion.

In Q4, e.l.f. Cosmetics grew 30% when the entire category was down 3%, allowing them to capture incremental market share by 325 basis points to 10.5%, which is up sequentially from 10.1% in Q4., Meanwhile, e.l.f. Skin grew 38%, outpacing the category by 19x and growing its market share by 45 basis points to 1.6%, which also grew sequentially from 1.4% in Q3, driven by the biocompatible skincare brand Naturium that they acquired in October last year. In terms of international expansion, net sales grew 115% YoY in Q4, contributing 16% of net sales, compared to 13% in the previous year. This was led by geographies that include Canada and the U.K., where it is the fastest growing among the top 10 cosmetic brands.

I believe that there are three key drivers of their outperformance across their growth pillars that include a) their strong value proposition of delivering high-quality products for every eye, lip and skin at compelling price points, with the average price point of $6.50, as compared to $9.50 for legacy mass cosmetic brands and $20 for prestige brands, b) a culture of product innovation, where it focuses on launching enduring product franchises, such as extending their Power Grip franchise into setting spray category with the launch of Power Grip Dewy setting spray at $10, compared to $38 for prestige equivalent, resulting in double-digit lift in sales, and c) engaging with their customers through unique and creative moments with their disruptive marketing engine, allowing them to reach new audiences beyond Gen Zs and creating brand awareness.

Simultaneously, the company also saw a 70% YoY increase in their digital consumption, with digital channels driving 22% of total consumption, compared to 18% in the previous year. I believe this is driven by the growth in members on their Beauty Squad Loyalty Program, which stands at 4.8M, up from 4.5M in the previous quarter, as they play a key part in their digital ecosystem, driving 80% of all sales on e.l.f.cosmetics.com. Simultaneously, the company management also remains focused on expanding its retail footprint to capture market share by replicating the success of its Target (NYSE:TGT) playbook, where it is the number one brand with over 19% share. During the earnings call, the management discussed that they will be expanding space with CVS (NYSE:CVS), Walmart (NYSE:WMT) and Ulta Beauty (NASDAQ:ULTA) during the course of the year, which, I believe, will help e.l.f. Beauty captures some of the whitespace, especially in its Skincare category.

The bad: While profitability expands, ROI on marketing can shrink if demand declines from macroeconomic pressure

Although the company generated $234M in Adjusted EBITDA in FY24 that grew over 100% YoY as it benefited from improving unit economics such as improvements in transportation costs, inventory adjustments, and international price increases, I believe that we need to be paying attention to the ROI of its SG&A expenses moving forward. In FY24, the company spent 51.4% of its net sales on SG&A expenses, up from 50.6% a year earlier. During the earnings call, the management claimed that they ended the year with marketing and digital spend (part of SG&A) at 25% of Sales, which is above the 22-24% range that they had originally guided. So far, the ROI from their marketing initiatives is yielding results, such as its partnerships with Liquid Death to launch Corpse Point which propelled a triple-digit lift in visits to e.l.f.cosmetics.com and sold out the collection in 45 minutes, with 68% of purchasers new to e.l.f.

At the same time, as the management looks to spearhead growth with its international strategy with expanding retail space with Superdrug in the U.K., Boots and Shoppers Drug Mart in Canada, and Sephora in Mexico, among others, I believe that return on marketing spend needs to be carefully monitored in order to assess the profitability landscape, especially if we see a slowdown in revenue growth from macroeconomic pressures. With interest rates kept higher for longer in the US, coupled with a weakening labor market and record high credit card debt, we may see a slowdown in consumer demand, which will lead to fewer units purchased per customer. Given that the company is already selling its products at “cheaper” prices compared to its competitors, a decline in units purchased will certainly put margin pressure on the company, forcing it to mass discount its products, especially at a time when it has built up its inventory by 135% YoY to $191.5M.

For FY25, the management expects to spend roughly 24-26% on Marketing spend with an Adjusted EBITDA margin projection of 21-23%, which will be in the similar range to FY24 Adjusted EBITDA margins.

Revisiting my valuation: e.l.f. remains a “buy”

Looking forward, the company expects to grow its revenue by 21% YoY to $1.24B with an Adjusted EBITDA of $287M, which would represent a YoY growth of 22% with a margin of 23%. The management’s revenue projection of 21% is lower than my previous estimate of 27%, which I had talked about in my previous post. While this marks a slowdown from the 77% YoY growth rate in FY24, I believe that the management has likely taken into account some possible macroeconomic headwinds dampening consumer demand while setting its FY25 revenue guidance. I believe that given the management’s execution thus far and the future growth strategies it has laid out to gain market share across its Cosmetics and Skincare verticals, while expanding its digital and retail footprint in the US and internationally as it drives robust product innovation and engages its user base through memorable brand moments, it should be able to grow in the high teens range over the following 2 years into FY27, translating into a total revenue of $1.7B during this period of time.

From a profitability standpoint, assuming that the company can continue to drive targeted price increases along with inventory adjustments to improve unit economics while maintaining a steady ROI on marketing spend as it continues to delight and convert its users, it should maintain an Adjusted EBITDA margin of 23%, which will translate to an Adjusted EBITDA of $397M in FY27, equivalent to a present value of $328M when discounted at 10%.

Taking the S&P 500 as a proxy, where its companies grow their earnings on average by 8% over a 10-year period with a price-to-earnings ratio of 15-18, I believe that e.l.f. Beauty should trade at least at 2-2.25x the multiple given the growth rate of its earnings during this period of time. This will translate to a price ratio of 38 or a price target of $222, which represents an upside of 22.36% from its current levels.

Although the strong level of marketing spend required to engage and convert its users as it gains incremental market share both in the US and internationally is an area of concern, especially if the ROI shrinks from falling consumer demand in the event of a possible macroeconomic slowdown, leading to margin pressures, I believe that the stock is attractively priced at current levels, especially given the whitespace of opportunity that is still ahead of it and the superior growth rate compared to its competitors that include L’Oréal, Estée Lauder (NYSE:EL), Coty (NYSE:COTY), Revlon, and others. Thus far, I have been impressed by the management’s execution, and I believe that it will continue to deliver superior outcomes given its long-term growth and product innovation strategies and its mission to deliver high-quality products at compelling price points, creating a sense of community and loyalty around its product. Assessing both the “good” and the “bad,” I believe there is still room for upside in the stock, and therefore I will rate it a “buy”.

Conclusion

I believe that the growth story of e.l.f. has further room to grow, given the magnitude of whitespace in its Cosmetics and Skincare category. I like how the company is driving robust product innovation coupled with memorable marketing moments to drive engagement both digitally and in its retail locations in the US and internationally to reach new audiences. Although ROI on its marketing spend will be scrutinized if the company sees a slowdown from short-term macroeconomic pressures, I believe the stock is attractively priced from a risk-reward standpoint, making it a “buy”.