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Morningstar | Substantial Brand Strength Underscores Favorable Trends in Beauty Industry

The global beauty industry has been a rare pocket of growth in the broader consumer landscape, growing at a roughly 4% rate over the last decade while other consumer goods firms have been plagued by lackluster volume, pricing pressure in categories facing secular declines, and heightened competition from niche players and private-label fare. We contend that several characteristics inherent to the beauty space, including a relatively price-insensitive consumer base, have helped these firms remain largely unencumbered by these pitfalls. We forecast the global beauty industry will be able to sustain mid-single-digit growth over the next five years as per capita beauty expenditures mirror broader increases in wealth and premiumization trends in the category persist. In our view, players with competitive advantages (including wide-moat L'Oreal and Estee Lauder and narrow-moat Shiseido) are best positioned to benefit from ongoing industry strength. Although we believe no-moat Coty lacks a competitive edge, its shares present a rare discount in this space; we'd suggest patient investors consider the name.

We suspect the substantial pricing power that these players have been able to exhibit is augmented by a risk-averse consumer base (placing more importance on a proven formulation than price) and limited degree of private-label penetration (amounting to a low-single-digit percentage versus the high teens we estimate for the broader consumer goods market). Moreover, they have invested significant resources behind their brands, in the form of marketing and research and development, in order to adapt to evolving consumer trends and maintain their visibility and differentiation in the eyes of the consumer. Entrenched relationships with retailers have further supported the brand equity of the top beauty players and provided them with the negotiating power to ensure that pricing remains consistent across a diversifying range of distribution channels.

The quickly growing digital and specialty channels have transformed the way in which beauty consumers interact with brands. Primarily, we think digital has had the most impact on brand discovery (with younger consumers more influenced by social media) and engagement during and after purchase (leveraging online beauty advisors, how-to videos, and personalized recommendations). However, we think consumers will continue to shop in brick-and-mortar locations, given the importance of trial and sampling product in the space. In this context, we've seen comparable sales and unit growth for specialty multibrand retailers (like Sephora and Ulta) materially outpace that of department stores, as the former have been able to capitalize on their differentiated store experience. We think companies that invest in their omnichannel capabilities can extract additional customer value; based on data from Ulta's loyalty program, consumers that shop both online and in stores spend nearly 3 times as much (including nearly twice as much in physical stores) as those that shop in stores only.

For additional detail on our outlook for the global beauty industry and analysis of competitive advantages in the space, please refer to our report "Looking Beneath the Surface: Attractive Dynamics Form the Foundation of Beauty Companies' Moats."