The Estee Lauder Cos (NYSE:EL) spooked the markets at the end of September when it announced excellent fourth quarter earnings but warned of future earnings uncertainty due to weakness in the economy. The guidance sent its stock for a tumble trading below $90. It's since regained most of those losses, closing October 14 trading at $97.97. Within 10% of its five-year high of $108.77, its price shouldn't scare you away. In fact, now is the time to buy.

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Inflation Protection
Estee Lauder's portfolio of brands is so strong that raising prices isn't an issue. Add to this a renewed commitment to cutting costs and you have the makings of a very powerful combination. Its gross margin in fiscal 2011 ended June 30, 2011, was 78%, its highest level in past decade. The same goes for its operating margin, which ended the year at 12.4%. Although its guidance suggests 2012 earnings could be in for a bit of a rocky road, analysts believe that its future is very promising. Linda Bolton Weiser, recently named the best analyst in the household and personal products category, calls Estee Lauder her single "best buy" recommendation in the category. The analyst expects it to earn $4.94 for the 12 months ended June 2013, giving it a price target of $109, which is based on a forward P/E of 22 times. You're not going to get rich here but if you look at its 10-year performance, you're not going to lose much either. In fact, over the past decade, you would have beaten the S&P 500 by 8.8% annually. (To take a deeper look at a company's profitability using profit margin ratios, check out Profitability Indicator Ratios: Profit Margin Analysis.)

Sales Growth
Estee Lauder's historical sales growth is between 6 and 9% annually. In order to maintain this growth, Weiser suggests four areas the company will exploit to remain on track. The first, not an original thought by any means, is to focus on emerging markets. The Chinese, both women and men, love their skin care and cosmetics products, and are willing to pay premium prices to get them. According to Trefis.com, the men's skin care market in China will reach $270 million in 2011, higher than in the U.S., and will grow 29% annually for the next three years thereafter. The Chinese government places customs duties on imported consumer goods like cosmetics, often making them 50% more expensive in China than in other parts of the world. This brings us to the second growth market, which is travel retail. Over a million Chinese tourists spent over $7 billion on luxury products in 2010 in U.S. alone. The customers Estee Lauder misses in China, it will hit at airports around the world. This plan appears to be working. In some of its recent quarters, travel-retail revenue growth has been upward of 45%. The third area for growth and quite possibly the one with the most potential is online sales. Currently, 15 out of its 18 brands have e-commerce sites yet its 2010 online sales revenue were $107 million, just 1.3% of its $8.8 billion in fiscal 2011 revenue. I see incredible upside potential for revenues and profits. Lastly, growth will come from specialty retailers like Sephora, who are slowly replacing the department store as the go-to place to buy cosmetics. Together, these four opportunities will keep it very busy.

Estee Lauder and Peers

Company P/FCF
The Estee Lauder (NYSE:EL) 28.2
The Procter & Gamble (NYSE:PG) 21.1
Avon Products (NYSE:AVP) 54.1
Elizabeth Arden (NYSE:RDEN) 15.8
Colgate-Palmolive (NYSE:CL) 19.8

Free Cash Flow
Over the past decade, Estee Lauder has grown its free cash flow an average of 15.3% annually. Its enterprise value of $18.65 billion is 28 times free cash flow, which puts it at the high-end among its peers. During this period, however, its free cash flow yield has remained around 4%, which confirms that its cash flow generation has kept up with its stock price. Look more closely at its use of free cash and you'll find a business that knows how to allocate capital. It's generated $4.3 billion in free cash flow over 10 years. Dividends, share repurchases and acquisitions amounted to $4.8 billion leaving a shortfall of $500 million, which came from additional debt. It carried out a good chunk of its share repurchases between March 2007 and June 2008, when it bought 19.1 million shares at an average price of $43.64 each. That's a return on investment of about 125% based on recent share price. Since then, it hasn't bought back nearly as many. That's self-control in action. (To learn more about free cash flow yield, check out: Free Cash Flow Yield: The Best Fundamental Indicator.)

The Bottom Line
Buying Estee Lauder at $98 isn't cheap; however, I consider it fair. Long-term, you'll do just fine owning this excellent cosmetics company.

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