The year 2013 has been a weak one for global cosmetics companies Estée Lauder (NYSE:EL) and L’Oréal (OTC:LRLCY). Despite posting mid-single digit growth in revenues throughout calendar year 2013, both companies underperformed the broader market. Estée Lauder’s stock gained 23% in value year to date while L’Oréal’s stock increased 22%. Comparatively, S&P 500 index grew 27%, while the S&P Global Consumer Discretionary index grew 32% year-to-date.
In the current article, we assess the reasons for the under-performance from Estée Lauder and L’Oréal, and take a look at potential short term and long term growth prospects in the Asia-Pacific market for both companies.
Emerging Market Currency Headwinds Smoothen Top Line Growth Trajectory
Expanding incomes and higher discretionary spending levels among emerging economies has resulted in a shift in business focus from developed markets to these high growth markets for companies across all sectors since 2008-09. This shift has hugely benefited companies operating within the consumer discretionary sector. Global leaders such as L’Oréal, P&G and Beiersdorf have competed and aggressively expanded their manufacturing footprint within the emerging market regions to tap into growth. An increase in investments into developing infrastructure within the new markets has fueled subsequent top line growth for these companies. This is reflected in the top line contribution from emerging markets for L’Oréal, which has grown from 29% in 2007 to 40% during CY2013. The share in revenues from Asia-Pacific for Estée Lauder during the same period increased from 14% in fiscal 2007 to 21% in fiscal 2013.
However, this growth in top line, propelled by strong demand from consumers in emerging markets, is beginning to moderate due to strong EM currency headwinds. Beauty companies L’Oréal and Estée Lauder, which have significant footprints within markets like China, India, Indonesia, Brazil and Mexico, have witnessed a deceleration in sales from emerging markets of Asia-Pacific and Latin America in 2013. Mature EM currencies in India and Brazil fell between 13% – 14% since the beginning of 2013, while the Indonesian Rupiah declined about 25% year to date against the U.S. dollar. The Chinese Yuan showed some resistance against the strengthening U.S. dollar, gaining 3% in 2013. This has largely contributed to the under-performance of both L’Oréal and Estée Lauder in 2013 against the S&P 500.
Looking ahead, we expect these companies to outperform the S&P index in 2014 as EM currencies look to have fully factored in the Fed’s decision to begin tapering its QE program. A recovery in developed markets of Western Europe and North America should further bolster the top line. However, revenues from countries like Indonesia, India and Turkey could decline further as their local currencies depreciate against the U.S. dollar owing to fundamental concerns.
Prospects Look Good For L’Oréal In Asia-Pacific As Estée Lauder Plays Catch Up
Although currencies have dented reported revenues for both companies, product volumes looked to be slowing down for Estée Lauder as constant dollar revenue growth began decelerating. Estée Lauder posted a 5% growth in constant currency Asia-Pacific revenues in fiscal 2013, compared to 8% and 10%, in fiscal 2012 and fiscal 2010 respectively.  L’Oréal’s constant currency revenues from its New Markets, however, remained fairly steady at 9.5% for the past three years. 
We believe the reason for declining constant currency sales in the Asia-Pacific region for Estée Lauder is its larger footprint in luxury markets like Japan and Korea, despite its presence in China. The Japanese economy has been stagnant for almost a decade, with prices continuing to spiral downward due to a deflationary environment. South Korea and Taiwan, which experienced strong growth between 1970-1990, are decelerating as they mature. The infographic shown below depicts market sizes along with the market growth rate in 2012 for the Asia-Pacific region. Japan, the largest beauty market in the Asia-Pacific region, has the lowest year-on-year growth rate for the market. Additionally, its premium pricing model has not gained significant traction outside mature EM economies as opposed to a mass-market model for L’Oréal.
(Source: Euromonitor International, November 2013)
Going forward, we expect L’Oréal to maintain steady growth in constant currency sales from the Asia-Pacific region due to its strong footing in countries like China and India. On the other hand, Estée Lauder’s prestige beauty products in Asia-Pacific could face some downward pressure in the near term, with growth in revenues from China offset by a comparatively larger presence in Japan and Korea than in India and Indonesia. Over a longer horizon, Estée Lauder could see support from the gently expanding Japanese economy and a strong demand for luxury beauty products from China, Indonesia and India as the company continues to expand its brand visibility in these countries.
L’Oréal too has been promoting its prestige skincare products within the Asian market citing higher growth within the market and greater customer adoption. This is a move to attract the mass-market consumer into the luxury segment by offering products in smaller packages at lower prices. According to Euromonitor, prestige beauty product sales across the world are witnessing higher growth than mass-market cosmetics (marked blue). We believe the company’s adaptation to this change in market dynamics would shape the business going forward for Estée Lauder and L’Oréal.
(Source: Euromonitor International, May 2013)Notes:
- Estée Lauder Annual Call Transcripts – FY2010, FY2012, FY2013, Seeking Alpha [↩]
- Financial News Releases, L’Oréal Investor Relations [↩]