Formed in 1946 by Estée Lauder and her husband Joseph Lauder...

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Formed in 1946 by Estée Lauder and her husband Joseph Lauder as a small family operated cosmetics firm in New York City, the Estee Lauder Companies Inc. (ELC) first carried only four products. ELC is now a leading consumer products company with over $12 billion in revenues, 46 thousand employees and products sold in more than 150 countries.
ELC operates in beauty products segment, manufactures and markets skin care, makeup, fragrance and hair care products. ELC’s products are sold under brand names including Estee Lauder, Aramis, Clinique, Prescriptives, Lab Series, Origins, Tommy Hilfiger, MAC, Kiton, La Mer, Bobbi Brown, Donna Karan New York, DKNY, Aveda, Jo Malone London, Bumble and bumble, Michael Kors, Darphin, Tom Ford, Smashbox, Ermenegildo Zegna, AERIN, Tory Burch, RODIN olio lusso, Le Labo, Editions de Parfums Frederic Malle, GLAMGLOW, By Kilian, BECCA and Too Faced. Its skin care products include moisturizers, serums, cleansers, toners, body care, exfoliators, acne and oil correctors, facial masks, cleansing devices and sun care products.
The maintenance of firm’s brands along with new product development and effective advertising is critical to the success of the company’s operations. Marketing and product innovations along with streamlined production and distribution, have contributed to growth, but the firm has also purchased brands through acquisition of other companies. In fiscal 2016, the company acquired Becca Cosmetics, their first colour cosmetic group acquisition since Smashbox in 2010. In November 2016, the company made its largest acquisition to date by acquiring California-based cosmetics company Too Faced for $1.45 billion.
The branded consumer products business is very competitive, and ELC battles the likes of Avon, Kimberly-Clark, L’Oreal, Colgate-Palmolive and Procter & Gamble. Like these companies, continual innovation is essential to the firm’s continuing profitability, so the firm maintains an extensive research and development operation, including marketing research and spends considerable amounts on advertising and promoting its brands.
The 2017 ELC Annual Report is the Appendix. Read the management letters and the Management Discussion and Analysis. Management communications are helpful in understanding the strategy and how the management is executing on that strategy. The stress on brand innovation and research is evident from ELC’s management letters.
After understanding the company, go to the financial statements, which along with the footnotes to the statements are our main focus for financial statement analysis.

1. On the basis of the information supplied, reformulate the income statements and balance sheets for 2017 to ready them for analysis using the following layout for the balance sheet.
As advertising, merchandising and sample expenditure is so important make sure you include these as line items in the reformulated statements. State your assumptions clearly as you do the reformulation. Review the reformulated balance sheet and summarize your key insights.

2. Calculate the return on common equity (ROCE) for years 2017 and 2016. For 2017 (2016) you can use yearly averages (end of year) amounts in ratios’ denominators.
Calculate the return on net operating assets (RNOA) for 2017 and 2016.
Comment on your findings. More broadly, discuss how the company’s profitability changed between 2016 and 2017.

3. Calculate sales growth rates for 2017 and 2016 and also growth rates for operating income from sales. Calculate growth rates for net operating assets for 2017. Do you see a trend? Is there any balance sheet item that particularly affects the growth?

4. What caused other comprehensive income loss in 2016?

5. Why did goodwill increase in 2017?

6. Operating profitability should be distinguished from return on common equity. Apply the financial leverage equation to highlight the difference. Is the firm favorably levered?

7. Calculate ROCE and its drivers RNOA, FLEV and SPREAD for 2017. What would be the effect on ROCE if operating profitability fell?

8. Calculate operating profit margin from sales for each year.
Calculate expense ratios as percentage of sales for advertising and promotion and R&D for each year. Do you see any trends? Carry out a comprehensive analysis of profit margin and asset turnovers (ATO) for 2017. In calculating ATO ratios use balance sheet amounts as averages for the year.
Using the margins, explain how cost of sales, operating and non-operating costs have been managed across the two years of 2017 and 2016.

9. What would be the effect on RNOA if profit margins changed? How might an increase in advertising and promotion affect profitability? In some years, translation gains/losses have big effects on total operating income. After excluding translation gains/losses and other non-sales items from operating income, calculate the return on net operating assets (RNOA) for 2017 and 2016. Comment on your findings and summarize key insights.

10. Prepare a pro forma forecasts of sales, operating profit margin (PM), asset turnover (ATO), Operating income (OI), RNOA and residual operating income (Re_OI) for years 2018 – 2021 under the following conditions:
i. 2018 2019 2020 2021
Sales growth rate per year 5% 6% 7% 7%
ii. operating profit margins and asset turnovers will be the same as in 2017.Prepare a pro forma forecasts of sales, operating profit margin (PM), asset turnover (ATO), Operating income (OI), RNOA and residual operating income (Re_OI) for years 2018 – 2021 under the following conditions:
iii. required return for operations is 9%
Use the forecasts of Re_OI to value the operations (VNOA) of the firm and calculate its intrinsic value of equity (VE).

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A financial statement analysis of Estee Lauder Companies Inc. is conducted whereby reformulated financial statements serve as basis for computation of financial ratios, which are crucial in the different levels and aspects of analysis performed. It has been determined that the Company has an increasing net profit margin of 9.90% in 2016 and 10.56% in 2017. In terms of financial position, the Company has net operating assets of $3,439 million in 2016, which rose to $5,332 the following year. Additionally, the Company reported net financial assets of $148 million in 2016 while a net financial obligation the year after of $930 million. Overall, the Company is assessed to be profitable based on various profitability measures, such as the return on net operating assets, where every dollar of investment generated $0.34 and $0.30 in 2016 and 2017, respectively, and return on common equity where the added value per dollar amounted to $0.27 in 2016 and $0.33 in 2017.
Reformulated Financial Statements
The set of comparative financial statements was obtained from elcompanies website. However, these statements have to be reformulated for meaningful...

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