Big On Beauty: How Cosmetics Corps Beat The Market

By TRANG HO, INVESTOR'S BUSINESS DAILY

 Posted 07/12/2013 06:59 PM ET

Here's the ugly truth: The age-old pressure to be beautiful is greater than ever.

And by nature, people want something they don't have. Anglo women bring on the bronzer. Asian women want whiteness. Older people pile on eye creams to look younger. Younger folks lay on color to look older.

Such desires have helped collectively drive the 29 names in IBD's Cosmetics and Personal Care industry group ahead 32% so far this year — one of the 30 best gains among the 197 industries tracked by IBD. The latest lift came from Nu Skin Enterprise (NUS) on Wednesday, when the maker of anti-aging products surged 19% after ratcheting up its second-quarter sales and earnings guidance.

Shoppers buy cosmetics near a L'Oreal advertisement in Nantong city, China. Cosmetics makers have turned to China, South America and other emerging... View Enlarged Image

Peers Prestige Brands (PBH) and Inter Parfums (IPAR) seconded the advance, each climbing 13% for the week.

Companies in the group produce hair, skin and bath products, make up, fragrances, shaving cream, nutritional supplements, over-the-counter medicines and weight-loss products. Globally, eight multinationals account for a fifth of the industry's worldwide sales. In the U.S., six companies — Procter & Gamble (PG), Estee Lauder (EL), L'Oreal (LRLCY), Mary Kay, Unilever(UN) and Johnson & Johnson (JNJ) — account for more than a fifth of the market.

Passport To Profits

Vanity and insecurity create an industry that sold $68.7 billion in the U.S. and $433.4 billion globally in 2012. Euromonitor International forecasts sales in the U.S. beauty and personal care industry will grow 3% to 4% annually over the next five years, reaching $81.7 billion by 2017.

The consumer market research firm sees global sales expanding about 5% annually to $562.9 billion by 2017. In 2009, the industry's only nongrowth year in the past five, U.S. and global sales dipped 1%.

Emerging markets have stepped in to fill the breach, propelling profits in the face of Europe's recession, slow U.S. growth and a lingering question mark over Japan. Driven by population and household-income growth, Procter & Gamble's developing market sales growth averaged 14% annually the past decade, according to its 2012 annual report. The Cincinnati, Ohio-based firm derived about 60% of its $83.68 billion in 2012 sales outside of North America.

P&G estimates between 2010 to 2020 the world's population will grow by 700 million, or about 10%, with 95% of the growth coming from developing countries. It projects the middle class to grow 98% over that period.

L'Oreal, the world's largest cosmetics firm, generated nearly 40% of 2012 sales, totaling $29.06 billion, from "new markets" in Asia, Eastern Europe, Latin America, the Mideast and Africa. With more than two dozen brands that span all price ranges and sales outlets, it leads the market in Mexico with expanding market share in Chile, Argentina and Uruguay.

L'Oreal owns the Maybelline, Lancome and SkinCeuticals brands. Last year, it acquired the Vogue group, Colombia's largest mass-market cosmetics firm. It built its largest factory to date in Indonesia "to meet the rapidly growing demand from the beauty market in Southeast Asia." It broke ground on the world's largest hair-coloring products factory in Mexico. It also founded a new subsidiary, L'Oreal KSA, in Saudi Arabia. Shares are up 22% year to date.

Nu Skin Enterprises, a direct seller of anti-aging, weight-loss and nutritional products, saw its sales in China rise 88% year-over-year in Q1, while European sales dipped 3% and U.S. sales ticked up just 7%.

"Our five-year business development plan (in China) includes tripling the number of stores and sales support centers by 2017 and expanding our direct selling coverage and distribution," Kara Schneck, senior director of corporate communications for Nu Skin, said in an email.

The company plans to roll out a weight-control system this year, adding to its ageLOC anti-aging product suite, and which analysts are banking on to drive future growth.

"In Asia, weight management (revenue) has grown almost 11% over the last five years, 10% year over year and is expected to expand at a 7% CAGR (compounded annual growth rate) over the next five years," Deutsche Bank research analysts wrote in a client note May 2.

"Globally, weight management across channels is a $13.3 billion industry while consumer health care direct selling is a $22 billion market, further highlighting the opportunity if Nu Skin can get its fair share of either pie," the report said.

Wedding Biotech And Beauty

The marriage of cosmetics and pharmaceuticals has given way to the industry's fastest-growing niche: "cosmeceuticals."

These use antioxidants, enzymes, proteins and peptides to create anti-aging regimens and multi-tasking products such as foundations with sun protection treatments. Cosmeceuticals generated an estimated $30.5 billion worldwide in 2011. The niche is on track to grow nearly 8% annually between 2012 and 2016, according to research by Farmington, Conn.-based Global Information.

The biggest players identified in its study were Johnson & Johnson, Bayer (BAYRY), L'Oreal, Procter & Gamble, Avon and Japan-based Shiseido.

Avon (AVP) launched 15 new products in 2012 bearing simple, catchy labels such as Anew Clinical Pro Line Eraser Treatment and Advance Techniques 360 Nourish Moroccan Argan Oil Leave-In Treatment.

That's helped hoist the stock out of a two-year correction and to a 56% gain so far this year.

The New York-based company runs research and development outfits in Argentina, Brazil, China, Mexico, Poland and South Africa. Avon owns nearly 100 patents. Estee Lauder owns a few more than that including 10 patents alone for its Revitalizing Supreme Global Anti-Aging Creme. L'Oreal boasts 600 patents.

Nu Skin's ageLOC, an anti-aging product suite of lotions, cleansers, pills and electronic devices, launched in 2008, drew $840 million in sales last year.

Balm For The Aging Masses

About two-thirds of the U.S. population is expected to be 55 and older by 2020, said Ron Robinson, a cosmetics developer and founder of BeautyStat.com.

"Fifty is the new 40," he said. "People are trying to look good at any age. Beauty products are the quick and easy answer to looking and feeling younger short of undergoing surgery."

Multicultural or mixed-race women will account for more than 40% of the U.S. population by 2020. That shift presents new opportunities for products catering specifically to a new set of hair and skin tones, Robinson added.

Waryness of synthetic products coupled with the hip allure of green living have fueled demand worldwide for plant-based products. Global sales of organic personal care products, which topped $7.6 billion in 2012, is projected to grow at an annual compounded rate of nearly 10% from 2012 to 2018, when they're estimated to reach $13.2 billion, according to Transparency Market Research of Albany, N.Y.

The leading brands in this niche include Estee Lauder's Aveda and Origins; and Bare Escentuals, acquired by Japan's largest cosmetics maker Shiseido in 2010. Also in the running: Burt's Bees, acquired by Clorox (CLX) in 2007.

Companies use unique ingredients — plant oils, vitamins or fruit extracts — to differentiate their products. Nut oils are natural replacements for chemicals like dimethicone, commonly used in skin and hair products for smoothing and conditioning, Jeff Menashe, CEO of the Demeter Group, wrote in a 2012 industry outlook.

Beauty products for men are less than a tenth of the women's market, according to NPD Group. Last year men spent less than $100 million on prestige skin care products and about $1 billion on fragrances. The male category is underdeveloped and holds great potential, said Karen Grant, vice president of beauty and a global industry analyst for NPD Group.

Inter Parfums, which has racked up a 74% gain already this year, owns exclusive rights to develop and market fragrances for specialty retailers and luxury designers. It seeks out brands without a fragrance line or lures away brands that are unhappy with their current fragrance maker.

"Our products represent an entry point for consumers into luxury brands where other products associated with those brands may be much higher priced," Russell Greenberg, executive vice president and chief financial officer at Inter Parfums, wrote in an email. "This has resulted in continued stability and growth of our sales."

Investment Risks

Fickle consumers: Some industry estimates say 80% of new product launches fail. Cosmetics are not regulated by the Food and Drug Administration and could face consumer backlash if they fail to live up to their ads.

A rising dollar: With half, if not more, of sales earned abroad, the industry faces decreasing foreign sales as the dollar appreciates and exchange rates become more volatile. Profits are also affected by commodity costs, with oil and natural gas among the key inputs.

Rising health care costs: These include insurance premiums and rising taxes to cover ObamaCare and bankrupt state, local and federal governments coupled with stagnant U.S. incomes. These factors are likely to hinder people's ability to buy luxuries of any kind, said Woody Brock, an economist and president of Strategic Economic Decisions in Scottsdale, Ariz. Consumer spending will be pinched for the foreseeable future "unless the middle class plunges into more debt," Brock said. "But that's unlikely given the prospects of retiring on cat food souffle."

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