asians drive the premium skin care market - Mirae Asset Global ...

Cosmetics, Asian RushASIANS DRIVETHE PREMIUMSKIN CAREMARKETAll roads lead to China. What's happening in thenew frontier?By Ahn Sol (Reserch Analyst at Mirae Asset Global Investments(HK))Worldwide cosmetics sales have neverdeclined in the past 18 years, and their annualgrowth rate was 4.4% between 1993 and2011. From 2001 to 2011, the Chinese skin/cosmetics market has shown a 17.0% growthrate, and premium skin/cosmetics markethas grown by an even faster rate of 22.3%.This is why China is often cited by cosmeticscompanies as a key market for growth. EstéeLauder, L’Oréal, Shiseido, Proctor &Gamble,etc. have been making substantial investmentsin the country over the past decade.Cosmetics market growth rates in Chinaare expected to decelerate compared to thepast 10 years, but we believe the industry canEmerging Markets Insight 9

Cosmetics, Asian Rushstill continue to grow by doubledigits and even faster forpremium cosmetics in thenext five years. In additionto nominal GDPgrowth and populationgrowth,urbanization willbe the stronggrowth driver ofcosmetics industry.Urbanizationis the top priorityof the new governmentin China. This isimportant becauseurbanization will not onlystimulate consumer adoption ofskin care and color cosmetics but, also,urban households tend to earn higherincomes than rural households which enableconsumers to trade up to more discretionaryitems such as premium cosmetics products.China's AttractionEmerging market consumers need to reacha certain level of income or GDP per capitabefore adoption of consumer products begin.This adoption wave typically starts withhousehold products like detergents andsoaps, extends to packaged foods such asinstant noodles and then moves up to relativelydiscretionary categories, which includemost personal care products. Skin care andcolor cosmetics are one of the later adoptioncategories, and deceleration occurs here generallymore slowly than other consumer products.Thus, cosmetics maintain faster growthrates for a longer period.China has grown to become the largest Asianmarket for two gigantic beauty players,namely L’Oréal and Estée Lauder. Chinaaccounts for 7% and 5% of L’Oréal’s andEstée Lauder’s total sales respectively. Andthis is purely sales from mainland China. Weassume Estée Lauder’s real sales fromChinese consumers to be around 15% of totalcompany sales, as Chinese consumers will bebuying Estée Lauder products in other placeslike Hong Kong, New York, and Paris. Accordingto Estée Lauder, every $1 spent in Chinaimplies an extra $2 in sales from Chinese outsideof China.The Chinese cosmetics industry trendfavors foreign luxury cosmetics players notonly because of its faster organic growth butalso because China (and Asia overall) is amore profitable market. The Asian cosmeticsmarket is over-indexed to premium markets.In China, the premium skin care market hasgrown to 26% of the total skin-care marketfrom 17% in 2001. Still, the premium marketshare is under-indexed to other Asian markets,thus we expect China’s premium marketto continue to outgrow the overall industry.Premium skin care has a 72% marketshare in Hong Kong, 59% in Taiwan, 57% inSouth Korea, and 55% in Japan, whereas it isonly 20% in Germany, 30% in the US, 44% inCanada and 48% in France. We believe Chinawill follow the same path as other Asian countries.This is definitely a tailwind for global cosmeticsplayers who are well-positioned in theprestige and premium market.Asian markets including China tend to offerhigher returns for many global cosmeticsplayers. This is because Asians spend moreon skin care products that tend to have higherprice points. Also, it is easier for companies topremiumize skin care products with addedfunctions. There are more opportunities toadd values on skin care products with whitening,anti-aging, brightening, etc., compared tocolor cosmetics or fragrances. Skin careaccounts for roughly 70% of the Chinesebeauty market whereas it is only 35% inNorth America, 32% in Brazil, or 37% inRussia. This is again an Asian phenomenon asskin care accounts for 62% of the beautymarket in Japan, 64% in South Korea and62% in India. For Estée Lauder, skin careaccounts for 60% in the Asia Pacific marketAsian markets including China tend to offerhigher returnsfor many global cosmetics players.26.8 22.4 20.6Source : TrefisUnit : %(forecast)US200620112015EUROPEcompared to that of 43% for the group. InChina, specifically, 82% of sales were incurredfrom premium facial care and the rest frompremium color cosmetics. Asian consumerstend to spend or invest more on skin carebecause of the increased cultural importanceof having well-maintained skin. A significantGlobal sales of Prestige cosmetics products37.3 36.1 33.44.4 5.1 5.8middle east, etc.JAPAN15.7 9.5 7.115.8 26.8 33.1Asia pacific (ex japan)Emerging Markets Insight 10

Cosmetics, Asian RushMNCs have stronger moatsin the household beauty andpersonal care (HPC) business.number of women are buying LV bags inChina, and we assume that these samewomen would be more than happy to pay apremium for their beauty.The Men's MarketAnother emerging trend in cosmetics is thefast-growing men’s grooming segment. Inthe past, it was almost taboo for Europeanmen to use skin care products, but this now ischanging. In fact, the popularity of the men’ssegment actually started in China. Accordingto the president of L’Oréal Asia, the companysaw a boom in men’s skin care in China andrealized the potential for the segment globally.It has become a larger market earlier in Asiabecause there is no such taboo for Asian menand partly due to Asian climates, as skin careproducts are more of a necessity in someregions. Still, cosmetics is largely women’scategory globally, but if it can be extended tomen, there will be another strong demandpull for the whole industry.Local players in Asia are generally verystrong compared to those in other emergingmarkets. This is because many Asian countrieshave solid competitiveness in manufacturing,and local companies usually have betterdistribution networks. This is especiallytrue for food companies. Food is an indigenousproduct and locals better understandtheir region’s tastes. We believe, however,that multinational corporations (MNCs) havestronger moats in the household beauty andpersonal care (HPC) business especially whenit comes to luxury or high-end consumergoods because then it becomes more of abrand game. Global cosmetics players wellunderstand such phenomena and thus investsignificantly in emerging markets.HPC is a purely brand business as a productitself is homogeneous and does not requiremuch localization unlike food. This provides aglobal HPC expenditureby category, 2011Total HPC:$925bnHome Care$142bn15%ConsumerHealth$198bn21%Hygiene$171bn19%Beauty &Personal Care$414bn45%Sources : Euromonitor, Bernstein analysisEmerging Markets Insight 11massive advantage to MNCs as they can easilyleverage their global heritage brands intoemerging markets. Local companies inemerging markets may somehow—albeit thisis also a challenge—make a breakthrough tomanufacture a good quality product, but evenif they do so, they cannot build a brand storyin one day. Also, MNCs tend to have strongermuscles for heavy advertisement and R&D.Particularly for cosmetics, since brand is soimportant, it can also be seen as an advertisementand marketing battle. L’Oréal and EstéeLauder spend around 30% of their sales onadvertising and promotions.The “Lipstick Effect”The cosmetics market is about aspirationalbrands which provide natural moats to MNCswith many global brands. As emerging marketconsumers acquire higher pricing powerwith double-digit wage growth in China, consumptiontrade-up will increasingly benefitglobal cosmetics companies. Such characteristicsare evidenced by the top 12 Beauty andPersonal Care (B&PC) companies having amore-than 50% global market share comparedto that of only a 17% share for the top15 global food and beverage (F&B) companies.The prestige and premium cosmeticsmarket will continue to be a game betweenonly a handful of global companies, just likeother luxury goods.Cosmetics is a unique category, havingboth staples and discretionary characteristics,and even luxury characteristics for prestige/premium cosmetics. It is a consumer staplebecause women (soon perhaps men as well)have to use cosmetics every day once theystart using them. At the same time, consumerstrade up to premium brands along with anincrease in discretionary income. In a recession,women tend to satisfy their luxurydemand with lower-ticket-price items andtypically they buy prestige cosmetics. This isthe so-called “lipstick effect.” Thus, cosmeticscategory growth is usually faster than otherconsumer staples goods in a good economyand it also tends to be more defensive thanluxury goods growth in slow economy.

Cosmetics, Asian Rushpersonal-care markets over the past decade,and Estée Lauder CEO Fabrizio Freda hasdeclared his intent to make it the company’s“second home market .” While the globalbeauty market has grown by 5% annuallyover the past 10 years, the Chinese beautymarket has expanded by 12% per annumover the same period. Prestige beauty hasproven to be a particularly dynamic segmentof the industry in China, growing in excess of20% each year.Skincare has been a key catalyst for prestigebeauty growth in China. Asian consumerstend to have more sophisticated skincareregimes compared to their global counterparts.An Asian woman, on average, will useeight different skincare products each day,including special products like whiteningcreams . A recent survey by China RealityResearch found that middle-class Chinesewomen are much more likely to trade up intheir beauty regimen, rather than tradedown in order to save money. The Chineseconsumer is most aspirational in terms ofskincare, as an overwhelming 68% surveyedsaid they would trade up compared to only2% planning to trade down.Fast-Growing Skincare MarketSkincare is a major strength for EstéeLauder, as it is the company’s most profitableand fastest-growing product segment. Assuch, the company has largely focused itsinnovation and advertising efforts in thisarea. In the fall of 2012, Estée launched aluxury skincare line specifically targeting thelocal preferences of Chinese consumers, inhopes to further penetrate the most importantmarket for the category globally. Osiao,as the brand is known, was developed over afive-year period with dedicated R&D specialistsin Shanghai who extensively studied differenttypes of Asian skin and téd the producton several thousand women across theregion. The company has ambitions forOsiao to become one of the major brands ofits Asian portfolio.A booming travel trend among emergingSales (Euro Million)3,5003,0002,5002,0001,5001,0005000Skin Care: Best Performing in Chinese Premium Category53% of Total2001Source : Euromonitor, UBS ReasearchSkincare Makeup Fragrances Hair etc.Estée Lauder is well-positionedto benefit from the seculartailwinds of the rising emergingmarket consumer.market consumers is yet another growthdriver for the prestige cosmetics industry.Estée Lauder has been able to capitalize onthe trend by shifting some of the focus awayfrom its traditional department store businessmodel toward faster-growing, moreprofitable channels, like travel retail.The company’s travel retail business hasbecome an especially important driver ofearnings growth in recent years, as it hasemerged as a key beneficiary of increasedtravel rates in Asia. Over the past decade,Chinese outbound travel activity has grownby more than 20% each year and is anticipatedto rise by 15% annually over the nextdecade to more than 100 million people .While traveling, consumers have anincreased proclivity to shop, whether in airportretail or downtown stores. And brands63% of Total2011with strong recognition in their home marketare more likely to be purchased by consumerswhen traveling abroad. Because of this,increased travel trends largely benefit multinationalcosmetics companies with strongbrand equity, like Estée Lauder. The companyrecently cited that for every $1 worth ofcosmetics sold in China, it is able to generate$2 abroad from Chinese consumers . Astravel retail trends continue to grow, EstéeLauder’s sales figures should follow closely inline.Estée Lauder offers a sustainable competitiveadvantage over its peers operating inthe personal care industry due to its pureplayexposure to the prestige beauty market,strong geographic footprint in emergingeconomies, and increased focus on highgrowth,high-margin product categories andretail channels. The company is well-positionedto benefit from the secular tailwinds ofthe rising emerging market consumer, and itcontinues to invest more heavily in the businessto gain market share globally.We believe this is one of the strongestglobal growth stories taking place in themarket today and will be following the companyclosely in years to come.Emerging Markets Insight 13

Cosmetics, Asian RushL´ORÉALDreams of OneBillion NewConsumersAs L’Oréal operates in categories acrossthe beauty spectrum, the company is ableto reach more consumers relative to itscompetitors and retain dominant marketsharepositioning.By Mirae Asset US research teamL’Oréal is a global beauty powerhouse.With $26 billion in annual sales last year, thecompany enjoys a commanding marketshare advantage over its competitors in thehome and personal care industry, such asProctor & Gamble, Unilever, and EstéeLauder. The company boasts a broad presenceglobally, with operations in 130 countriesacross 27 international brands.Over the next decade, the company is targetingone billion new customers. Seculargrowth trends in the global personal careindustry, increased investments in innovationand marketing efforts and a focus ongrowth markets and categories shouldenable L’Oréal to reach this goal. Home andpersonal care is an $820 billion global industrywith a projected annual growth rate of6.4% through 2020, up from 5.1% from2001-2011. Emerging economies of Asia andthe Middle East/Africa are expected to drive60% and 27% of this growth, respectively.As these countries develop and their consumptionlevels converge with those of moremature markets, it is estimated the industrycould be six times as large—nearly $5 trillionglobally. Personal care currently accounts fornearly half of the industry’s sales and has thehighest expected growth rate among all subsegments,with beauty products emergingas a clear winner .L’Oréal is expected to benefit from theglobal growth of the home and personal careindustry. Revenue growth of personal carecompanies correlates highly to increasingincome and consumption levels in emergingmarkets.Global ReachTherefore, exposure to growth is largelydetermined by a company’s geographic footprint.In 2012, emerging markets accountedfor almost 40% of L’Oréal’s total sales, with agrowth rate of nearly 10% on a year-overyearbasis. Asia Pacific and Middle East/Emerging Markets Insight 14

Cosmetics, Asian RushAfrica regions made up more than 60% oftotal emerging-market revenue. And thecompany anticipates 75% of its futuregrowth to come from the developing world .As a result, locally relevant innovation,increased manufacturing capacity, and abroad retail presence in these regions havebecome strategic pillars for L’Oréal.One of the company’s core beliefs is thatbeauty is founded in technology. As such,L’Oréal invests heavily in R&D initiatives tobolster its innovation pipeline. Research hubshave been established in all major geographiesin order to study local markets anddevelop formulas that meet the preferencesNorthAmerica25.0%L’Oréal global sales (2012) and research centersL’Oréal has 6 regional hubs, 19 reasearch centers and 16 valuationcenters for R&D.35.6%EuropeNew Markets39.4%Source : L’OréalBy offering products at variedprice points, L’Oréal appeals toa broader consumerbase than its competitors.Unit : %14Annual Growth Rate12Global Beauty IndustryL’Oréalof the specific consumer base. L’Oréal hasalso been at the forefront of developing andpatenting molecules used in their anti-agingproducts. The United Nations has citedunprecedented and pervasive aging trendsacross the global population in the 21st century,with no parallel in human history .Aging demographics, coupled with boomingconsumption trends in the personal careindustry, should lead to a sustained increasein demand for anti-aging beauty products,both in developed and developing markets.While Estée Lauder competes strongly in theprestige segment of this category, L’Oréal’srobust innovation platform should help thecompany to gain further share in the prestigeand mass markets globally.Everything and EverywhereThe depth and breadth of L’Oréal’s productportfolio offers yet another competitiveadvantage over its industry peers. The companyoperates in mass, luxury, salon, cosmeceutical,and natural beauty categories.1086420-2 2002 2004 2006 2008 2010 2012Source : L’OréalBy offering products at varied price points fastest-growing markets and categories willacross a wide range of distribution channels, drive L’Oréal’s success in years to come. TheL’Oréal appeals to a broader consumer base company will be a major beneficiary of seculartailwinds from rising emerging marketthan its competitors. Employing a differentiatedproduct strategy, in conjunction with consumption trends, particularly in the personalcare industry, and will retain dominanthigh levels of marketing and R&D spend, hasenabled L’Oréal to consistently outpace the market share positioning through a robustgrowth of the global beauty industry .innovation pipeline and strong marketingL’Oréal has emerged as the leader in globalbeauty. A continued focus on the world’s future looks bright forplatform. One billion consumers agree: theL’Oréal.Emerging Markets Insight 15