LTGG Reflections: eyes lips face

Capital at risk

Two decades ago, e.l.f.’s founders in Oakland, California, decided to apply a crucial lesson from fast fashion to the beauty industry. Using an outsourced, heavily vetted and low-cost manufacturing base, e.l.f. sought to respond rapidly to customers’ feedback by iterating and refining their products to provide what customers wanted. This remains an enduring source of the company’s competitive advantage. It allows for prestige quality cosmetics to reach mass market consumers – and at least twice as fast as incumbent cosmetics companies. With a reputation for great value combined with quality, e.l.f. now ranks as the leading make-up brand for Gen Z consumers.

Bricks-and-mortar retailers, such as Target, Walmart and Ulta, are allocating increasing amounts of shelf space to e.l.f. to keep up with demand for its hit ‘must-have’ products. Overseas, e.l.f. has similarly created links with retailers and other partners, such as Nykaa, a leading Indian beauty retailer that we met with in Mumbai last year.

However, e.l.f.’s success isn’t solely thanks to its reactive supply chains, high-quality products and shelf space. Another significant catalyst for its rapacious growth has been a deeply differentiated and remarkable online marketing strategy. Some four million loyal e.l.f. customers have been converted into brand advocates (known as the “e.l.f. Beauty Squad”). They benefit from special offers and advance purchases while spending time interacting with the brand’s social media channels and providing feedback on its products. The result is a clear sense of online community. Consumers are engaged in a fun, relatable and interactive way. The focus is on real user reviews, as opposed to highly paid beauty influencers. Feeling involved in the creation process appears to be a core part of the community appeal.

This marketing strategy has given rise to some of the most viral marketing content on platforms such as TikTok. And it hasn’t been a one-hit wonder – multiple campaigns across different platforms have generated billions of views and vast engagement from Gen Z and Millennial users. Moreover, the brand’s messaging around authenticity and cruelty-free products resonates deeply with the target audience. In a sign of further innovation, e.l.f. is making a step towards the livestream social commerce that we see elsewhere in the world. The brand is also opening up to a broader demographic, with recent primetime Super Bowl ads featuring the likes of Jennifer Coolidge and Judge Judy. 

For e.l.f., the cosmetics industry nowadays is as much about entertainment as it is about cosmetics. Kory Marchisotto, Chief Marketing Officer, has supercharged this phenomenon. But e.l.f.’s workplace culture likely also plays a role – its small headcount and its young and diverse workforce are in striking contrast to the Parisian besuited executives of traditional beauty brands.

Turning to financials, the cosmetics industry is not the most obviously exciting growth market. However, we know enough from LTGG’s previous holding in L’Oréal (held from 2004 to 2020) that brand strength and repeat purchase behaviour can give rise to formidable growth with considerable longevity. For e.l.f., annual net sales recently surpassed $1 billion – a doubling in just three years and a symbolic milestone in challenging the established beauty giants, many of which are still reeling from digital disruption. Underneath its rapacious 77 per cent topline growth has been impressive financial performance, with gross margins reaching over 70 per cent and return on equity of 25 per cent.

Where to from here? Our upside case for e.l.f. mostly hinges on it taking more market share. For context, the US mass market for cosmetics accounts is estimated at $28bn, of which e.l.f.’s share has doubled in recent years to nearly 4 per cent (still far behind L’Oréal’s 20 per cent and Estee Lauder’s 10 per cent). Beyond further US growth and overseas expansion (its non-US sales are more than doubling year-on-year), growth levers also include expansion into product adjacencies such as the higher-margin and rapidly growing skincare segment. 

For a 5x upside case, we believe it’s entirely plausible that sales could compound at 25 per cent pa over the next five years and slow to 20 per cent for the subsequent five, meaning that total revenues could reach close to $8bn by 2034. That would still only be half of Estee Lauder’s sales and less than a fifth of L’Oréal’s. Net margin is already around 15 per cent (similar to the best-in-class), meaning e.l.f. could be making over $1bn in profits within a decade. In such a scenario, a quintupling of the $9bn market capitalisation to $40bn would require a 40x price-to-earnings multiple in 2034 (vs. over 80x today). This doesn’t seem outlandish given its potential to outpace the single-digit growth generated by the more mature players in the industry. Indeed, its price-to-sales ratio would be around 5x, similar to L’Oréal’s today.

This may just be the start of an emerging and enduring super-brand growth story, one worthy of a place among the world’s leading growth companies. We therefore took a holding for the LTGG portfolio in April 2024.

Risk factors

The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in June 2024 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

Potential for profit and loss

All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.

This communication contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.

All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.

The images used in this communication are for illustrative purposes only.

Important information

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.

Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.

Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.

Financial intermediaries

This communication is suitable for use of financial intermediaries. Financial intermediaries are solely responsible for any further distribution and Baillie Gifford takes no responsibility for the reliance on this document by any other person who did not receive this document directly from Baillie Gifford.

Europe

Baillie Gifford Investment Management (Europe) Ltd (BGE) is authorised by the Central Bank of Ireland as an AIFM under the AIFM Regulations and as a UCITS management company under the UCITS Regulation. BGE also has regulatory permissions to perform Individual Portfolio Management activities. BGE provides investment management and advisory services to European (excluding UK) segregated clients. BGE has been appointed as UCITS management company to the following UCITS umbrella company; Baillie Gifford Worldwide Funds plc. BGE is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co. Baillie Gifford Overseas Limited and Baillie Gifford & Co are authorised and regulated in the UK by the Financial Conduct Authority.

Hong Kong

Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 and a Type 2 license from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of collective investment schemes to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 can be contacted at Suites 2713–2715, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. Telephone +852 3756 5700.

South Korea

Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.

Japan

Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.

Australia

Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth) and holds Foreign Australian Financial Services Licence No 528911. This material is provided to you on the basis that you are a “wholesale client” within the meaning of section 761G of the Corporations Act 2001 (Cth) (“Corporations Act”).  Please advise Baillie Gifford Overseas Limited immediately if you are not a wholesale client.  In no circumstances may this material be made available to a “retail client” within the meaning of section 761G of the Corporations Act.

This material contains general information only.  It does not take into account any person’s objectives, financial situation or needs.

South Africa

Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.

North America

Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005 and is registered with the SEC. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in North America. Baillie Gifford Overseas Limited is registered with the SEC in the United States of America.

The Manager is not resident in Canada, its head office and principal place of business is in Edinburgh, Scotland. Baillie Gifford Overseas Limited is regulated in Canada as a portfolio manager and exempt market dealer with the Ontario Securities Commission (‘OSC’). Its portfolio manager licence is currently passported into Alberta, Quebec, Saskatchewan, Manitoba and Newfoundland & Labrador whereas the exempt market dealer licence is passported across all Canadian provinces and territories. Baillie Gifford International LLC is regulated by the OSC as an exempt market and its licence is passported across all Canadian provinces and territories. Baillie Gifford Investment Management (Europe) Limited (‘BGE’) relies on the International Investment Fund Manager Exemption in the provinces of Ontario and Quebec.

Israel

Baillie Gifford Overseas Limited is not licensed under Israel’s Regulation of Investment Advising, Investment Marketing and Portfolio Management Law, 5755–1995 (the Advice Law) and does not carry insurance pursuant to the Advice Law. This material is only intended for those categories of Israeli residents who are qualified clients listed on the First Addendum to the Advice Law.

MSCI Legal Disclaimer

Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

104132 10047679