- Industry growth under pressure
- New brands emerging
The word daigou means “buying on behalf of” in Mandarin. It refers to the practice of purchasing goods – often luxury items – outside of China before returning to the country to sell them on. Handbags, clothes and shoes can cost 30 per cent more in China than in Europe.
This ‘grey’ market is an important source of revenue for luxury names, including US beauty giant Estée Lauder (US:EL). The group went “full steam ahead into the daigou business” in recent years, according to HSBC, and its travel retail revenue – which covers sales made in duty-free malls, airports and on cruises – was swelled by demand from daigou operators.
The Chinese authorities have started to stamp down on resale activity, however, and Estée Lauder is suffering. After a flurry of downgrades, it reported a 6 per cent fall in organic net sales in the year to June 2023 “primarily driven by Asia travel retail”, and operating income more than halved to $1.5bn (£1.2bn). The situation was made worse by a “slower than anticipated” recovery in China itself.
Investor fatigue
Estée Lauder’s daigou problem is just one part of a complex picture, but it reflects broader issues within the company – namely, a lack of long-term thinking from management, which seems willing to endanger brand equity in exchange for quick returns.
“Estée Lauder has been complacent and surprisingly short term, given it is controlled by a family,” said HSBC analysts, comparing its actions to those of fashion brands which became overly reliant on outlets and damaged their image. The group’s share price has crashed in the past three years and it now trades on a third of its 2021 peak. Shares in French rival L'Oréal (FR:OR) have climbed by 7 per cent in the same period.
Fund manager Terry Smith sold Estée Lauder last year, telling investors that the “mishandling of the demand/supply situation in China following reopening post Covid and in the travel retail market revealed serious inadequacies in its supply chain”. Analysts have also turned sour: Morgan Stanley and Goldman Sachs both downgraded the company to ’neutral’ this year after losing faith in its turnaround plan.
L’Oréal, in contrast, remains “a long-term favourite” of Smith, who said its “handling of the China market contrasts sharply with that of Estée Lauder”. Despite softness in mainland China and the “reset” in travel retail, L’Oréal managed to grow like-for-like sales by 11 per cent in 2023 and operating profits jumped by 20 per cent to €8.1bn (£6.9bn).
Scale and diversification is proving crucial. L’Oréal and Estée Lauder are the two biggest beauty companies in the world, but L’Oréal is three times bigger than its rival, with a market share almost equivalent to Estée Lauder, Unilever (ULVR) and Procter & Gamble (US:PG) combined. As well as its geographic reach, it sells a more diverse range of products, including some cheaper brands, which has helped offset recent weakness in the luxe division.
L’Oréal also has immense marketing power, pumping over 30 per cent of its revenue into advertising campaigns every year, compared with around 23 per cent at Estée Lauder. (It seems to be working: the tagline ‘Because you’re worth it’ has stuck around for more than 50 years).
Growing pains
L’Oréal could be at risk of losing its glossy credentials, however. After several years of above-average growth, analysts are concerned about the beauty sector’s prospects. “We think a structurally slower China, downtrading West and [less scope to raise prices] will send market growth lower, undershooting the long-run average of 4-4.5 per cent in the near term,” analysts at Jefferies concluded.
Even if L’Oréal keeps outperforming the market, therefore, there is a risk that too much is expected of it.
The landscape is also becoming more competitive, with independent brands using social media to reach audiences in a way that would have been prohibitively expensive in the past.
A survey carried out by US investment bank Harris Williams found that over half of 18-24 year-olds find beauty products via TikTok, and incumbent brands will have to be nimble to keep up. The struggles of lipstick-icon Revlon – which was founded in 1932 but fell into bankruptcy in 2022 – is a warning of what could happen. (Revlon has since emerged from bankruptcy after cutting its debt and handing control to its lenders.) Eerie tech companies like Oddity (US:ODD), which harvests selfies to help match consumers with make-up products, are also gaining traction.
The Chinese market looks particularly vulnerable to fragmentation, with local brands gaining more prominence and online shopping platforms such as Douyin (TikTok’s Chinese counterpart) lowering barriers to entry. This is reflected in recent shopping data. Singles Day, or Double 11, is an unofficial holiday and shopping season in China. In 2023, local brand Proya ousted L’Oréal from the top Singles Day spot, bagging the most pre-sales in the skin care sector.
Because they’re worth it?
The pressure on beauty incumbents is not yet reflected in their valuations. L’Oréal trades on a forward price/earnings ratio of almost 34 times and Estée Lauder is barely less expensive at 31 times. High-end label Shiseido (JP:4911) trades on true luxury rating of 48 times, while also seeing sales and earnings fall in recent years.
UK-listed Warpaint (W7L) operates at the other end of the market and trades on a PE of 21 times, even after its share price has doubled in the past 12 months. For those bullish on Western cosmetics holding on to market share in the face of Chinese challengers, midcap Warpaint and behemoth L’Oréal could prove complementary.
