Elf Beauty has emerged as one of America’s most sensational consumer brands over the past decade. The cosmetics group is experiencing incredible growth, is very profitable and looks capable of offering more of the same.
The success of Elf products is due to its appeal to Generation Z, built on expert marketing and product innovation. The brand promises high-quality and affordable products that are not tested on animals, clean and vegan, to its mainly young customers. These values are reflected in a board and workforce that is young, diverse and more than two-thirds women.
If this is all starting to sound a little woke, even an investor deep into the pit of the counterculture war will find it hard to argue with the company’s financial performance.
Elf has achieved compound annual sales growth of 27 percent and adjusted earnings per share of 34 percent over the last five calendar years. Gross margins (before operating costs) were 71 percent and return on capital employed was 20 percent in the last reported financial year to end March 2023.
The balance sheet is also solid: net debt at the end of 2023 was equivalent to 0.9 times earnings before interest, tax, depreciation and amortization (EBIT).
Elf, which stands for ear, lips and face, was founded in 2004 as an online-only brand; this was a necessary move due to a beauty magazine’s insistence that products have national distribution to feature in its pages.
The company’s rapid growth attracted private equity backing before it listed on the New York Stock Exchange in 2016. It has since attracted investment from some of the world’s best-performing fund managers.
12 of these professional investors, each in the top 3 of more than 10,000 stock fund managers tracked by financial publisher Citywire, own shares in Elf. As a result, Citywire Elite Companies, which rates companies based on the backing of the world’s top fund managers, achieves the highest AAA rating.
“Creating brand equity around their products has been incredible,” says Fred Stanske, manager of the top-performing FullerThaler Behavioral Small Cap Growth fund, which counts Elf among its top 10 holdings.
Behind the success is the fact that Elf is an extremely smart operator. Combining high margins, high quality and low prices is not a circle of many squares. The key to Elf being able to achieve this is its asset-light “hybrid supply chain.” In practice, this means having flexible relationships with many Chinese suppliers, including keeping some on standby.
It stays very close to these suppliers. At the end of the last financial year, China was home to about a quarter of the total staff of 420. This proximity allows for close work with suppliers on product innovation.
This is another thing where Elf looks very good. It uses social media to keep up with trends and launch new products surprisingly quickly.
While the average turnaround time for new launches is just 20 weeks, some hit the market in as little as 13. Meanwhile, Elf’s own digital marketing for these products is getting stronger as customers brag about their products online.
In the financial year to the end of March 2023, 22 per cent of net sales, or $126 million (£99 million), went to marketing. Proof of its effectiveness is that Elf’s share of the U.S. market for color cosmetics (eye shadow, foundation, lipstick, and so on) increased from 4.1 percent to 9.8 percent in five years. This moved it from the fifth largest mass market player to the third position.
The company now expands its brand awareness beyond Generation Z with national TV campaigns. At the same time, international sales are rising, compared with about 70 percent at longer-running peers; this rate currently accounts for 14 percent of the total.
Skin care is another huge growth opportunity. Last year’s $355 million acquisition of Naturium doubled the proportion of group sales in this product category to 18 percent. The US skin care market is only slightly smaller than cosmetics; an estimated $7 billion versus $6 billion, but it is growing faster, at 6 percent per year versus 1.5 percent. This leaves Elf with plenty of opportunity for growth.
Despite its online roots, the bulk of the group’s revenue now comes from major retail chains. Its top three customers generated 60 percent of revenues last fiscal year. This concentration of sales is a risk, but Elf is a brand that retailers have every reason to stock up on as its products are flying off the shelves.
Another risk for shareholders is valuation. At 57 times estimated earnings for the next 12 months, the rating is in nosebleed territory.
But some of the world’s top fund managers believe the shares are worth it, given high returns on capital, an exemplary record and continued growth forecasts; Earnings per share are forecast to more than double last year’s level by 2025. This column agrees.
Questor says: to buy
Indicator: NYSE:ELF
Share price at closing: $200.91
Algy Hall is investment editor Citywire Elite Companies
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