Overweight Estee Lauder, Underweight Brown-Forman: Morgan Stanley's Pair Trade Scenario

Morgan Stanley's Dara Mohsenian maintained an Overweight rating for Estee Lauder Companies Inc EL, with a price target of $105. He recommended switching to the company’s stock from Underweight-rated Brown-Forman Corporation BF

Estee Lauder and Brown-Forman made a “Good Pair Trade,” analyst Dara Mohsenian said. He explained that Estee Lauder’s valuation did not fully reflect the company's higher-than-peers EPS growth and returns, while Brown-Forman’s decelerating topline trends were not fully factored into valuation.

Similarities Between The Companies

Despite having exposure to different product categories, there were a number of similarities between the companies, Mohsenian commented. Both the companies:

1. Compete in attractive product categories
2. Are family controlled
3. Manage their business from a longer-term perspective
4. Have been selective about M&A
5. Have somewhat similar geographic mix
6. Have driven shareholder value significant above peers over the last decade, backed by robust organic sales growth

Divergence

“Going forward, we believe the business models will start to diverge. We believe EL is in the midst of an organic transformation to sustainably higher revenue growth (through more favorable channel and brand mix), and to a lesser extent higher margins (through mix/topline leverage/greater cost-cutting),” the analyst wrote.

In contrast, Brown-Forman is likely to generate slower organic sales growth going ahead than what it has been able to achieve over the last decade. The company’s growth is expected to be impacted by “an international slowdown that has already emerged” as well as decelerating US results due to an intensifying competitive landscape, the Morgan Stanley report stated.