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Showdown In The Cosmetics Department

Posted: Aug 20, 2008 08:01 AM by James Brumley

Tickers in this Article: LIZ, RDEN, EL

Elizabeth Arden (Nasdaq:RDEN) would probably like its "Red Door" line of cosmetics to paint it back into the black. The cosmetic company took a loss this past quarter, although it did so for an apparent strategic reason. Rival Estee Lauder Companies (NYSE:EL) took the shortcut; it simply went ahead and boosted earnings now.

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Is there enough room at the cosmetic counter for both? There always has been, but I think one of these two rivals is far-better positioned than the other. In fact, the other one may have a little too much faith in its recent coup.

Twin Lizzy
Elizabeth Arden and Liz Claiborne's (NYSE:LIZ) fragrances have united. In fact, Arden's licensing agreement with Liz Claiborne fragrances was the reason it slipped into the red this quarter. The $19.6 million led Arden to a loss 38 cents per share. If the company not taken the hit for the Liz license, it would have profited 22 cents per share, which is in line with expectations.

So, what exactly did Arden get for $19.6 million? That's the question Arden shareholders have asked, but unfortunately they may have a tough time finding answers. Even in Liz Claiborne's SEC filings there's not a lot of detail.

For what it's worth, however, Liz is considered a "partnered brand", and this segment of Liz Claiborne's business did $389.6 million in sales last quarter. It produced $884 million in revenue for the first six months of the year. This is nice, but both were well under last year's comparables. Oh yeah, partnered brands lost $87 million over the first half of the year, which is not exactly encouraging.

It is not clear how much of the business - good or bad - is now Arden's. There are a surprising number of brand names in the mix, even though Liz Claiborne (which included clothing) seems to be one of the big ones.

However, Liz's loss may not necessarily translate into trouble for Arden. If the (details-undisclosed) deal is like most licensing agreements, it's a percentage-of-sales deal, probably with a guaranteed minimum. It's not like Arden is buying a company outright; it's just acting as a middle-man and taking a cut of course. (For all the fuzzy details, read "Elizabeth Arden, Inc. and Liz Claiborne Inc. Enter Into Licensing Agreement for Liz Claiborne Fragrance Business".)

Liz Claiborne's Strange Problem
Even though Arden isn't completely on the hook here, I have to think some of the problems Liz confessed to will also be met by Arden. Specifically, Liz Claiborne said in the quarterly filing:

"Our department store customers' continued focus on inventory productivity and product differentiation to gain competitive market share and improve margins and cash flows ... This operating environment continued to adversely affect our Partnered Brands segment and contributed to reduced sales in the following brands: Liz Claiborne, Claiborne, and Enyce."

I hesitate to speculate what they're actually trying to say here. The statement explains very little, but I don't think it's too far off to discuss the possibility that they don't really have an explanation. Focusing on "inventory productivity and product differentiation to gain competitive market share and improve margins" is the normal course of business for department stores. It has been for years. Now it's a problem for Liz?

That's not to say the Liz-Arden partnership will be a bad one for Arden, but, given that we don't really know what the fiscal impact of licensed Liz fragrances could be for Arden (I personally suspect something under 100 million in sales annually), paired with the problems Liz acknowledged in the latest 10-Q, I don't see this news as a big boon for Arden shareholders.

Remember, even without the one-time licensing expense, Arden just met analyst's expectations last quarter. Now, Estee Lauder on the other hand...

Estee Lauder Needs No Partner
No fanfare needed here. Estee Lauder's net profit grew by 36% last quarter. The company can thank a boost in overseas sales for that. My immediate concern was simply that the dollar - which has strengthened in the meantime - may cut into that demand going forward. As it turns out, even without the benefit of favorable exchange rates, Estee Lauder's sales were still up 9%.

From a price-to-earnings perspective, Arden is the better value with a forward P/E of 10 while Estee Lauder sits around 17. However, given Lauder's organic growth trend versus Arden's potential mistake adding Liz fragrances to the mix, I think Estee Lauder is the prettier one right now.

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By James Brumley

James Brumley is a freelance writer and registered investment advisor. He began his career as a broker with a major Wall Street firm, where fundamentals and long-term holding periods were core strategies. After that, he switched gears completely, becoming an analyst at a short-term trading newsletter that focused on technical analysis. He now manages client money using the best of both philosophies. His company, Bluegrass Portfolio Management, offers investors an opportunity to reap superior returns with minimized risk.

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