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The Beauty Industry: An Attractive Investment

Bertrand Eury, Consumer Discretionary and Retail Analyst

At Arnhem, we aim to capitalise on emerging consumer trends to pick long-term winners in growing markets. We believe Beauty is a very attractive industry that is benefiting from multi-year tailwinds. Trends such as premiumisation, higher use of make-up amongst Millennials and Gen Z consumers, beauty bloggers and celebrity backed brands, increased rate of women in emerging markets entering the workforce, more people traveling internationally and a proliferation of new products and niche brands, should see Beauty sales grow in the mid to high single digits going forward, with the premium category growing even faster. These trends bode well for global Beauty players such as Estee Lauder, L’Oréal or LVMH, even though they will have to adapt to stay relevant in a fast evolving competitive landscape.

Premiumisation of Beauty products is driving outsized growth. Within the overall Beauty market, the premium channel has outperformed the mass category by a wide margin. Similar to other consumer goods categories (from spirits to baby diapers), this trends towards premium products has helped the industry to report strong growth rates and robust margins. The market has clearly picked up on this, as reflected by the strong stock price outperformance between luxury players such as Estée Lauder and LVMH and mass markets peers such as L’Oréal (mix is c.50% high-end, c.50% mass) or Coty.

Beauty Industry Share Prices, January-01-2017 to October-01-2017:

LVMH: 71.28%
Estee Lauder: 68.8%
L’Oreal: 35.46%
COTY: -16.01%

Source: Capital IQ

Source: Euromonitor and JP Morgan

Make-up is now the fastest growing category within Beauty. Over the last decade, Skin Care, the largest category within Beauty (market size of USD$120bn), was the key area of focus for brands as the category was benefiting from mega trends such as an ageing population and a rising middle class in emerging markets. While these trends are still at play, Make-up, a category about half the size of Skin Care, has recently taken over to become the fastest category in Beauty.

Source: Euromonitor and JP Morgan. Men’s grooming Ex Razorblades

Source: JP Morgan, Euromonitor

We believe the strength in this category is structural and the story has legs. The desire to be “selfie-ready” and the ubiquity of social media has a younger demographic using more make-up. The proliferation of online video tutorials expanding consumer education and helping to encourage users to try and purchase a wider breadth of products, facilitates this trend.

“Millennials are much more about immediate results than saving for the future,” Estee Lauder CEO Freda said in an interview with the Wall Street Journal. “The 30-year-old today gets more photographs of themselves in a day than their mother did in a year, so they care about what their skin looks like now, not when they are 40.”

Asia, already the world largest cosmetics market, will continue to grow strongly. At c.34% of the global market by value, Asia is the largest economic region for Beauty. Despite its size, consumption per capita remains significantly lower in Asia ex-Japan compared to that of Western markets. We do not see any structural reasons to prevent consumption increasing to a level closer to that of developed markets, especially as disposable income continues to increase and Chinese tourism increases globally.

Asia has historically been a skin care market, with Chinese consumers historically spending little on make-up or fragrances. The consumption of make-up is now rising strongly in the region, particularly in China, as a new generation of consumer is emerging, influenced by Western trends and local beauty bloggers.

Source: Korea Health Industry Development Institute, Macquarie Capital (USA), August 2017

Estee Lauder CFO Tracey Travis, 1Q18 earnings call: “Part of the growth of make-up is driven by the fact that the Asian women have discovered make-up.”

Proliferation of alternative channels have lowered barriers to entry… The beauty industry has long been diversified in terms of distribution channels, from department stores, to pharmacies, airports, all the way down to the Avon ladies. What has changed is further segmentation of distribution with the rise of ecommerce (still only 7-10% of industry sales today), specialty retail formats such as ULTA and Sephora (owned by LVMH), fast beauty (E.L.F. Beauty), pure-play internet beauty retailers, and more recently subscription-based models where fashion experts send products to your door based on what you like (or what they think you like..). The proliferation of alternative channels has had the effect of lowering barriers to entry. Not only has there never been so many avenues to get a product to market, but the internet, mobile and social media engagement provide small and unknown brands with a cheap and easy way to gain recognition with word of mouth and recommendations. Interestingly, despite a lack of equity and financial backing allowing them to be distributed by mainstream retailers, we have recently witnessed numerous small new entrants gaining an outsized amount of market share and challenging incumbents.

Source: Euromonitor

… Enabling small brands to gain share at the expense of the more established ones. It is not usual anymore for niche brands to grow to $200m in sales in just a few months and reach $1bn+ valuation. These brands, which are typically backed by celebrities or are differentiated (e.g., organic cosmetics), have strong social media followings and are viewed as “authentic” and not mass-produced, something that big global brands can’t easily replicate.

As per a recent WSJ Article, Coty’s Bart Becht said younger consumers have different shopping patterns preferring to buy beauty products online, as well as being more drawn to less mainstream brands. “Generally they are looking for more natural products and more authentic brands,” he said.

Companies like Dollar Shave Club become viral success stories, thanks to their social media-centric marketing and quirky advertising. Celebrity backed brands like actress Jessica Alba’s The Honest Company and reality star Kylie Jenner’s Kylie Cosmetics have also had huge success. Kylie cosmetics, which launched in November 2015, has done a whopping $420 million of retail sales in the last 18 months. This growth shows no signs of slowing, with the company on track to see a 25 percent increase in sales this year. Estee Lauder owned Tom Ford Beauty took over a decade to reach $500 million in sales (admittedly the brand is now a powerhouse with sales of $1bn+). Whilst these up and coming brands can disappear as fast as they rise to fame, we would not discount the ‘staying power’ of more established brands. Moreover, the beauty conglomerates have had to react by acquiring the disrupters, increase their social presence and pay big dollars to hire influencers. Estee Lauder acquired Too Faced for USD$1.5bn or 6 times sales. L’Oréal acquired CeraVe for USD$1.3bn or 8 times sales and IT Cosmetics for USD$1.2bn or 7 times sales…

The industry will continue to consolidate. The market remains fragmented with the top 10 players accounting for ~50% of the market. Given the trends highlighted earlier, we believe the larger players will continue to consolidate the industry and acquire faster growing brands that are complementing their portfolio. M&A activity has been on the rise, with LVMH, Estee Lauder and COTY particularly active in acquiring smaller brands they cannot create organically. In particular, premium beauty brands have become significantly more attractive investments, commanding premium valuations.

Source: Euromonitor

The lower barriers to entry have led to a myriad of smaller brands gaining share in the market. However whether these brands have staying power and can resonate outside their core market remains to be seen. As such, we still believe that Beauty leaders leveraged to premium products and China growth will continue to outperform. Estee Lauder, LVMH and to a lesser extent, L’Oréal, check all these boxes. They have undoubtingly had to change their act, pushing their online and social media presence to compete more effectively, yet have work to do to reposition their portfolios. It seems like consumers aren’t the only ones trying to keep up with the Kardashians, after all.

Bertrand Eury is the Consumer Discretionary and Retail Analyst in Domestic and International Equities. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.
This article has been prepared by Arnhem Investment Management Pty Limited ABN 17 129 606 775, AFSL 332484. It has no regard to the specific investment objectives, financial position or particular needs of any specific recipient. You should seek your own professional advice in relation to any financial product referred to. You should also obtain the product disclosure statement relating to any financial product referred to and consider the statement before making any decision about whether to acquire the financial product.

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© Arnhem Investment Management, 2017