The Booming, Yet Overlooked, Business of Beauty

The 10-step cleansing, exfoliating and moisturizing process that is the cornerstone of a Korean woman’s skincare regime and is, the experts say, largely responsible for her flawless complexion is an arduous and demanding practice that requires commitment and an arsenal of products.

Yet it’s a process in which Mumbai, India-based Nidhi Sharma-Punjabi believes strongly and practices religiously every night.

She does so not just because, as beauty editor of Vogue India, she’s well-versed in beauty practices, products and the science behind the Korean method.

No, this young woman is also emblematic of the New India — a vibrant space where economic improvement continues to drive rapid social change, and where skincare and beauty are becoming more and more important to large segments of the Indian population.

Despite the old adage, beauty has never really been in the eye of the beholder. In an era of rampant social media, where the “selfie” is the yardstick of individual expression everywhere, societies across the world are more appearance-focused than ever.

“People across the globe are posting online, and they want to look as good as they can up close,” said Cindy Mu, a CFA who is a global consumer research analyst on mutual fund complex Artisan Partners’ growth equity team in Milwaukee. “They’re hungry for beauty products and cosmetics, and they’re spending more on beauty — particularly in emerging markets, where income levels are rising. As growth investors, we believe this industry has great prospects.”

Yet Mu is one of the few investors in the beauty space — an industry that, despite consistent strong performance and enormous potential, has been vastly overlooked, according to Harvard Business School Professor Geoffrey Jones, who authored “Beauty Imagined: A History of the Global Beauty Industry.”

Jones believes that investors’ disregard of the beauty sector has much to do with the continued gender imbalance in the financial services industry. Men tend to default toward industries like information technology, he said, because they can relate to these more than to creams and concealers.

“But that lack of understanding and the view that there’s a certain ‘fluffiness,’ for lack of a better word, about the beauty industry completely misses the fact that this is an incredibly fast-growing industry with plenty of opportunity — one that is highly innovative, demands high marketing skills and a high degree of creativity,” Jones said. “Today, beauty has become a global phenomenon, and an industry that once had relevance only in places like Paris, London and New York has become relevant to consumers everywhere.”

From DIY to Drugstore and Beyond

Only a generation ago, few Indian women wore much makeup. They defaulted to their kitchens for skincare, mixing up homemade treatments made of yogurt, honey, gram flour (ground chickpeas) and lemon juice. Over all, store-bought brands were few.

Today, though, India is in the throes of a complete beauty revolution. “Indians are consuming beauty through every channel — they’re reading magazines, watching videos, following beauty bloggers,” Sharma-Punjabi said.

Ravenous Indian consumers now also have access to a plethora of beauty and skincare products, and brands — ranging from American drugstore to French pharmacy, from everyday Korean to prestige Japanese — have been flooding the Indian market.

More importantly, the outlook on beauty is rapidly changing in India, Sharma-Punjabi said. Larger segments of society are embracing both skincare and makeup as de rigeur and experimenting with different kinds of products — primers and essences, serums and sheet masks — and cosmetic looks.

In addition to Vogue India’s affluent readership, “there’s a growing segment of people in India with more money to spend — people who would not shy away from buying a Chanel mascara despite the price tag, and telling others that they’re wearing a Chanel mascara,” Sharma-Punjabi said.

These are the consumers that cosmetics brands are targeting and tailoring their products toward, with special formulations that are relevant to the Indian market — skin whitening products, which are in huge demand in India, and foundations for darker skin tones, to name just a few — and via celebrity spokespeople (Bollywood bombshell Alia Bhatt is the face of Maybelline in India).

Stable, Strong and Growing Returns; High Margins

With an impressive 14% year-over-year growth in 2015, the Indian beauty market experienced the greatest growth of any country, according to data from London-based firm Euromonitor.

Currently at $514 million, “the Indian market is still small,” Ildiko Szalai, senior analyst at Euromonitor said, “but it has lots of potential to grow.”

India embodies what Szalai underscores as the two greatest drivers of the global beauty industry: self-expression and individualism. Both of these, she said, “go hand-in-hand with greater disposable income, higher employment, a burgeoning middle class” and all the other traits of the booming consumer economy that is India’s.

But all across the globe, beauty has been and still is an industry that provides solid and steady returns, Szalai said. It’s a sector that held up well even during the 2008-2009 financial crisis.

According to a report from the firm Research and Markets, the beauty industry clocked in revenues of $379 billion in 2013, and that should grow to $461 billion by 2018. Skincare is particularly significant as a sub-sector, and is expected to grow to $106 billion in revenue in 2018 from $83 billion in 2013.

From an investment point of view, beauty company stocks offer very high margins, said Ron Robinson, New York-based founder of Beauty Stat, a niche beauty influencer platform that reaches over 20 million consumers.

Cosmetics, for example, are marked up by about 80%, and this contributes to strong margins given that it’s easy to store makeup and fairly inexpensive to ship it. Ditto on the skincare side, where “the pricing structure is very profitable for many brands, especially in the prestige sector for names such as Sisley and La Mer, where skincare products can start selling at $100 and sometimes go as high as $1,000, but often the cost of making those products is really not very high, which keeps profit margins high,” Robinson said.

Brand loyalty is also important in contributing to strong profit margins (Estée Lauder, for example, enjoys an 80% profit margin). However, beauty companies large and small work hard to retain their clients by innovating and keeping up with consumer-driven trends, Robinson said, be that anti-aging products, skin lightening creams and all kinds of special formulations for changing demographics.

“Today, the big urban clusters of the world are very much mosaics of different ethnicities, and they are driving current trends in beauty, makeup and fashion,” Jones of Harvard Business School said. “Historically, the non-White markets have been underserved, and there’s a huge potential to cater toward them that is driving the beauty business.”

From New Niche to Old World

To that end, a host of smaller brands in the beauty space are increasingly attracting investor interest.

These companies are niche players, said Katie Johnson, business manager at San Francisco-based CircleUp, which raises capital for early-stage companies in the consumer space, and they’re able to create targeted solutions to emerging consumer demands.

CircleUp has helped startups like Thrive Skincare, a plant-based brand for men, and The Seaweed Bath Co., access capital from different sources. Entrepreneurs who start these kinds of companies are fast to respond to consumers’ desires, Johnson said, and gather a following by leveraging technology and social media to create brand awareness.

For investors, these companies are also interesting because larger conglomerates that are constantly on the hunt for strong, niche players often buy them out.

Beauty M&A is also a growing industry, Johnson said.

Large beauty companies like L’Oreal and Estée Lauder have purchased numerous brands, both locally and internationally. That’s just one of the reasons why Harvard’s Jones believes that investors can never go wrong by buying their stocks.

These diversified conglomerates have always been strong, positive performers, he said. They have a solid presence in international markets and various product lines that are both innovative and well-suited to different ethnic groups — Hispanic, Black, Asian — in the U.S. and Europe.

According to Zacks Equity Research, Estée Lauder netted sales of $3.13 billion in the second quarter of 2016, marking a 3% rise from the second quarter of 2015. The company — which owns a number of prestige and mass market brands including Bobbi Brown, Clinique, MAC and Smashbox — increased profits by 3% year-over-year to $2.54 billion. It continues to derive a significant amount of its earnings from emerging markets while placing great importance on constant and focused innovation, which is crucial to deliver both revenue and profits.

The K-Beauty Boom

Artisan Partners’ Mu has increased her exposure to Japanese prestige brand Shiseido.

Founded in 1872, Shiseido is the largest beauty company in Japan and the fifth largest globally, but its business has suffered in recent years as a result of poor management and Japan’s declining share of the global beauty market.

“Currently, Shiseido’s margin levels are subpar compared to peers like L’Oreal and Estée Lauder, but we think there’s an inflection point here because of a new management team that came on board in 2014 with a new CEO — the first one ever selected from outside the company,” Mu said. “He has a Western management style, he’s very growth oriented and he likes to move fast, so we think Shiseido can close the margin gap fast. With investing in R&D, they can continue to grow.”

But for Mu, the greatest driver of the global beauty sector is Korea, where a deeply ingrained beauty culture has created a sharply focused industry that may be the most dynamic in the world.

For Koreans inside and outside the country, proper skincare and appearance are paramount. In Myeongdong, Seoul’s shopping mecca, eager buyers load up on cosmetics and beauty supplies by the suitcase, while Korean mothers like Hyeseon Kim, an adjunct professor of Korean culture at Penn State University’s Altoona campus, teach their sons from an early age to take care of their skin properly using high-quality products.

Korean consumers are extremely savvy, and they want products that are functional, appealing to the eye and effective. If they’re not satisfied, they will move on very quickly, said David Cho, co-founder of New York-based online retailer Soko Glam. This forces cosmetics companies to continuously push the envelope and create the highest-grade formulations — products that are backed by solid scientific R&D — and present them in an attractive way at the best possible price.

For a long time, Korea’s beauty industry was something of a national secret. It was virtually impossible to find products outside of Korea, and the constant demand from families and friends overseas for these products is what led Cho and his wife, Charlotte — both of whom were raised in the U.S. but spent time in Korea — to set up Soko Glam.

Soon enough, though, “K-Beauty” became one of the biggest drivers of the beauty industry, with the masses embracing the 10-step process and the multi-tasking BB cream, long used by Korean women in lieu of foundation. Essences, sheet masks and cushion compacts created a furor, and snail mucin — a key ingredient in many Korean products that has been touted as an anti-aging panacea since the time of Hippocrates — is now common parlance in the lexicon of beauty.

Because skincare is so important in Korea and because Korean customers are so demanding, manufacturers are held to strict standards by the government through the Korean Food & Drug Administration (KFDA), Cho said. R&D is paramount, and new products are subjected to tough scientific rigor, he said. Cutting-edge labs with the best possible equipment are constantly testing the properties of new ingredients such as volcanic ash, gold and placenta.

Many users of Korean products (this writer included) can attest to their efficacy, and four years after its launch, 70% of Soko Glam’s client base is non-Korean, Cho said. The company carries over 30 Korean brands on its website, and is constantly developing relationships with new ones.

However, even though Soko Glam just closed a very successful first round of funding that raised around $2 million from private and institutional investors, most of Wall Street has yet to catch onto the K-Beauty craze.

“Many investors here don’t know what K-Beauty is, which is why we’re so interested in the sector,” said Jay Nogueira, associate portfolio manager for T. Rowe Price’s Global Growth Equity Strategy.

Like Mu, Nogueira is a keen investor in Amorepacific, a Korean cosmetics company whose stock has tripled in the last two years (Ticker: 090430 KS, listed in South Korea), fueled largely by strong sales in China. The company is expanding more and more into the U.S., upping sales of its prestige labels in department stores, and its mass-market products in retailers like Target.

“Amorepacific has only a $10 billion market cap in the U.S., so if we’re thinking five to 10 years from now, we’re talking about a really big company, especially given how fast China is growing,” Nogueira said.

Ditto for another of Nogueira’s favorites, LG Household & Health Care (LGH&H — Ticker: 051900, listed in South Korea), whose cosmetics unit — the second largest in Korea — has boomed as a result of strong sales in China and duty-free sales to a continued influx of Chinese tourists visiting Korea.

From a price point, both Amorepacfic and LGH&H are good value for investors because they’re not so widely known, so their stocks are affordably priced, Nogueira said, offering plenty of growth potential.

China: The New Frontier?

Korea’s forte is that it has been able to come up with a constant supply of moderately priced products that not only purport to have the same effect as high-end ones, but actually live up to their word.

This has revolutionized the beauty industry, said Mary Schook, a New York-based cosmetic chemist and licensed esthetician, who has also helped numerous Korean brands enter the U.S. market. The same process is starting in China, which Schook believes is poised to become the next Korea.

“There’s a hunger in China,” she said, “both from consumers for whom beauty and skincare have become more and more important, and also from entrepreneurs who are creating new brands.”

These include companies like Yue-Sai Cosmetics, which was set up in 1990 by Chinese-American Emmy-winning television host, producer and entrepreneur Yue-Sai Kan and purchased by L’Oreal in 2004; and Inoherb, one of the earliest Chinese companies to infuse traditional herbal medicine into skincare formulations, as well as a number of others.

While regulatory standards and product transparency are still gray areas in China, Schook believes that Chinese consumers will push the bar higher for better quality products and formulations. Already, she said, “China is putting out a quality that they didn’t have before, and strong demand is resulting in high-caliber craftsmanship.”

The E-Commerce Play

It’s not easy, of course, for U.S. investors to get both intelligence on and access to China’s booming beauty industry, but Nogueira said a great way to access the sector is by investing in e-commerce companies.

Globally, e-commerce and m-commerce (product sales via apps like Instagram and social media sites like Twitter and Facebook) are the fastest growing retail platforms, Euromonitor’s Szalai said. In the beauty space, they totaled 6.4% in 2015. In China, internet retailing in the beauty sector accounted for 18.1% of sales in 2015, a huge jump from the 2.6% recorded in 2010.

That’s why Nogueira is interested in companies like Alibaba, China’s — if not the world’s — largest online retailer. Alibaba and its subsites like Taobao, Tmall (which now sells four Estée Lauder brands) and AliExpress reach millions of consumers across the globe.

E-commerce has certainly changed the beauty business in India. “It used to be that Indians would only be able to buy beauty products when they traveled abroad, and they had to wait until they traveled again to replenish their stock, but now, you can order your brands online and so your usage is uninterrupted,” Vogue India’s Sharma-Punjabi said.

Nogueira is also keeping tabs on beauty retailers Sephora and Ulta, whose businesses — both in-store and online — are booming. Sephora, which has a strong presence in India and China, is trading at 32 times price-to-earnings.

“We don’t have big holdings right now because from our point of view, the valuations don’t make sense, but we continue to monitor them for any changes,” Nogueira said. “In 2013, Ulta’s stock went from 113 to 85 in a few months, so you never know.”

— Read “Wealthy Women vs. Wealthy Men: 4 Key Differences in How They Invest” on ThinkAdvisor.

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