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.

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