I could see a scenario over the next 6 to 12 months where I think mortgage rates could easily be 100 basis points lower than they are today. Why? Well, because I think the Fed's going to cut a little more aggressively than the market's pricing in, but also think that mortgage spreads will compress from here as well.
Hello and welcome to the Baron Street Wise podcast. I'm Jack How and the voice you just heard is Andrew Scizarowski. He's the strategic income portfolio manager at Morgan Stanley Investment Management. And in a moment, he'll explain what's next for mortgage rates and why for investors, mortgage-backed securities look attractive. We'll also look at the wild ride recently in shares of E.L.F. Beauty and we'll hear from that company's CEO and a top Wall Street cosmetics analyst.
Listening in is our audio producer, Alexis Moore. Hi, Alexis.
I'm going to do my best here. I'm going to put on a brave face. I do have a mild burn on the tip of my tongue. I got too aggressive recently with some corn on the cob. What happens is you pull it out of boiling water and a corn on the cob will hold its heat for a long time. But, you know, corn's delicious. So, there's always a difficult standoff where you got to wait long enough to not burn yourself, but you don't want to wait too long 'cause you can't wait to get into that corn. And I didn't wait long enough. But I'm going to push through. Please don't call me a hero. Now, I want to talk about E.L.F. Beauty. You are familiar with this company's products, correct?
Yes. E.L.F. eyes, lips, and face.
Right. It's a little E, little L, little F, right? Very Gen Z, but then a capital B on beauty. It's the name, if I'm being honest, it's like being as much of a pain in the neck with somebody having to write that name as possible. But we'll give him a pass for that. If you look at the chart of this stock, this thing has been public since 2016. And this is a stock chart that would scare off a memecoin trader. This thing has been wildly volatile. But depending on when you bought it, you might also have made great money. Over the past 5 years, the stock has returned 492%. That compares with 106% for the S&P 500. Growth has mostly been rapturous over the years. There have been a couple of exceptions. The stock debuted in 2016. The IPO price was $17 a share. It closed the first day of trading over 26. And then over the next two years, the stock price got cut in half. There was a rare sales decline for the company. The company's CEO at the time, Tarang Amin, responded by closing the company's own stores and focusing on its sales through national retail partners as well as through its website. He also improved marketing. I want to focus on the period that started with the stock's high price over $200 a share last summer and ran through a steep decline into the 60s, followed by a rebound to about $120 recently. Just this month, there was a 9% decline when the company reported quarterly financial results, followed by a 10% gain when Morgan Stanley upgraded the stock. The recent volatility comes down to this. ELF is a company that makes most of its goods in China and sells most of its goods in the US. And now we have higher tariffs and some tariff uncertainty. And ELF has had to respond by raising prices. It did so by a dollar. That's a dollar on pretty much everything across the store. Ever hear of something called the lipstick index? It's a well-known economic phenomenon that I'm pretty sure is total baloney. It was put out there by a cosmetics tycoon a couple of decades ago. It holds that women are supposed to buy more lipstick during economic downturns. The theory is it's an affordable luxury. It makes them feel better. I haven't seen any evidence that that really happens. But on the subject of liponomics, here's a very real economic phenomenon. It's called price elasticity of demand. It's the degree to which a customer will pull back buying a certain good if the price goes up. For some goods or some customers, the elasticity is high and others not so much. And that to me is an interesting case study that's playing out right now in E.L.F. beauty shares. If a $7 lipstick goes up by a dollar, that's a big percentage increase. But at the same time, it still looks good relative to that $50 lipstick. So, just what does the elasticity of demand look like for E.L.F.? I don't think investors are quite sure, and I think that explains the stock's recent volatility. Everyone's waiting to see, and that's as much as I can tell you. Let's hear more about the company from Tarang.
ELF Beauty has been around for 21 years. We got our start selling cosmetics over the internet for $1. Everyone thought the founders were crazy. This was 2004, pre-iPhone, you couldn't sell cosmetics over the internet and you certainly couldn't make money at a dollar. But that spirit of disruption has been with us ever since. We've since migrated to other channels. Our main customers in the US would be Target, Walmart, Ulta Beauty, wherever you'd buy mass cosmetics. We are still strong online with a great business at Amazon or elfcosmetics.com. We're the number one brand amongst Gen Z, but what we're most known for is still making the best of beauty accessible to every eye, lip, and face.
How do you figure out what your next hit product is going to be? I mean, one way, I would imagine, is you look for something out there that people like that's $100 or $150. You figure out a way to make something similar that's $15 or $20. I would imagine that that's a good route. Is that something you do? What is your R&D or in-house development process look like?
I'd say two things. First of all, we're big believers in having our team reflect our community. So, our workforce is 74% women, 76% Gen Z and millennial, 44% diverse. They absolutely are the community we serve and probably the richest source of insights in terms of what's hot, what's trending. They obviously look at the data. We have an incredible innovation capability. But the other great thing about us is we're known for our community engagement. We know our community where they live, what they like, and a lot of times our community tells us exactly what they want. My CMO sometimes terrorizes me by dragging me on TikTok Live. It's under our theory of zero distance between the C-suite and our community.
I was just going to ask how your social media game is personally, but go ahead.
So my social media game is probably woefully inadequate, but luckily ELF Beauty is quite strong. So my CMO will drag me on TikTok Live. There was a time I won LA on last year and she's like, 'All right, you got the big boss now. Tell them what you want.' I'll look at the chat field and it'll light up and it's like, 'Oh, there's this prestige brand. It's got these bronzing drops. We love them, but they're $38. I can't afford $38. Help us out, ELF.' And I'll say, 'Okay, yeah, yeah, okay. You guys want bronzing drops.' And then there'll be like another two dozen chats like, 'No, no, boss man. We want them now.' Like I said, I'll leave that TikTok pretty traumatized. I'll call my head of innovation. And I'll say, 'Please, we have a three-year product pipeline. Please tell me we have bronzing drops somewhere in that product pipeline.' And she says, 'Yes, we do.' I'm like, 'All right, great. When are they coming out?' It's like 18 months. I'm like, 'No, no, you don't understand. I cannot go on another one of those TikTok lives and have our community yell at me.' So, we introduced them within 6 months and at a fraction of the price. I think ours came out at $9 versus the $39 prestige item. And we do that over and over again. Importantly, our ability to react to that quickly, be able to have that innovation capability, be able to deliver that prestige quality at a fraction of the price.
I won't ask whether folks in the office have started calling you boss man like your fans on social media, but tell me about where you are in the company's growth. In other words, for investors, what's your ambition for the company 5 years down the road, 10 years down the road? I see these headlines about pushing into new stores or expanding your relationships with stores. How much room is there to go? Do some of the retail partners get at all nervous about other competing products that sell at much higher prices?
You know, one of the great things I've been CEO of ELF Beauty for 11 and a half years. Every time I get a new candidate, I tell them, 'Oh my god, you are joining us at the exact right time because we're just getting started.' And I fundamentally believe that. If you take a look at our net sales, we're about $1.3 billion. We feel in the coming years we can more than double that, get past $3 billion. We see white space in color cosmetics, skin care, and international. In color cosmetics, we're now, as I said, the number one unit share brand in the US, number two dollar share with clear line of sight to market leadership. But if you look at Target, which was our first national retail customer, we're their number one brand with over 21% of their entire category. And the only difference between Target and everyone else is Target had a five-year head start on everyone else. And we're seeing the same trajectory with every one of our customers where we are the most productive brand a retailer will carry. Highest dollar per linear foot sales. We're very proactive in changing out our assortment to make sure we keep that high productivity taking insights from our digital channels. And then we have two of the fastest growing skincare brands in ELF Skin and Notorium. Both distinct and complementary but very fast growth. And then we're in the very early days of our international expansion. International is only 20% of our business today. For many of our global peers, it's over 70%. And the great news because of that strength that we have in social, we see pent-up demand for ELF well before we get into a country. In the last year, every retailer we've launched into, we've launched into the number one to number three position. You know, we had a launch last year with Dloss Italy. Dloss is more of a prestige shop. And we asked Dloss, you know, we don't even have any Italian consumers. How much should we modify this brand for the Italians? They said, 'No, not much. Italians like hot American brands.' The only argument we had with them is we have the number one SKU in color cosmetics in the US, our power grip primer. They told us Italians don't use primers. We're like, you know, we're a test and learn. We're digitally native brand. Why don't we put it in and if it doesn't work, we'll sub it out with something else. Sure enough, not only is ELF the number one brand into gloss, but PowerGrip Primer is the number one item in their entire store.
I'm learning so much here. Italians do use primer even though they thought they didn't. I'm going to Google primer after this. I'm going to go down a whole internet rabbit hole on that one. For more on E.L.F. beauty, I reached out to Olivia Tong. She's a beauty, personal care, and household products analyst at Raymond James, and she's bullish on E.L.F.
Beauty is a fantastic category in so far as it typically does grow volume and price on a regular basis and there's no shortage of real estate on your face. People are always interested in looking for more opportunities to make them feel better and look better. From that perspective, it's really interesting. Number one. Number two, their average price point is $6.50. Mass average is $10ish. Prestige sky's the limit. So it is democratizing accessibility for these products. Also really importantly they advertise pretty extensively. They spend about 25% of sales on average year in and year out on advertising which you don't typically see with value-oriented brands.
Is it the case that I know that this is a company with some tariff exposure and maybe they need to raise prices. Was that an issue? Is there anything that you see with this brand that leads you to think that there's a demand issue that customers are pulling back or going elsewhere? Or do you see a company that's still growing in a healthy way? It's just that maybe investors' expectations got too high or that sort of thing.
