Betting on Make-Up

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The cosmetics market is poised to grow during the coming decades. As emerging markets such as Brazil, Mexico, India, and China grow, the number of middle income families soars. Once families become richer, their consumption patterns change. According to Nielsen, cosmetics are one of the first categories that families include in their portfolio when they feel richer. The reason? Women are usually the ones in charge of going to the store. Here I take a look at three global leaders in the cosmetics market.

Top brands, rich valuation

Estee Lauder (NYSE: EL), the global manufacturer of skin care, make-up and hair care products, counts on strong brands, such as Estee Lauder, Clinique, MAC and Bobbi Brown, and distribution networks. The company has robust top-line momentum (with sales expected to grow by 8% in 2013), which I would expect to continue throughout 2013 thanks to the resurgence in consumer spending in the U.S. and some emerging markets, such as Brazil. It's important to stress how this resurgence in consumer spending is happening above all among upper income consumers, which is the group that buys products from Lauder. Besides, the company keeps on gaining market share, which I think its the most relevant information for any consumer goods company. 

Given that the company trades at a 2013 P/E of 25 and pays a (low) 0.30% cash dividend yield, I would not go long at current prices. It's a good company but its price seems a little bit too high. Besides, its $15.5 billion market capitalization makes Estee Lauder a tough M&A target. 

A perfect M&A target within the space

While growing its top line fast at 10.5% year-over-year, Elizabeth Arden (NASDAQ: RDEN) continues to make good progress on its key growth initiatives: (A) the repositioning of its Elizabeth Arden brand (with the ambitious goal of doubling sales by 2018), and (B) growing its Western European fragrance sales and market share.

Since not everything could be good news at the company's results, gross margins declined by 1% to 49%, owing primarily to negative product mix. That said, I am convinced that Elizabeth Arden will continue to deliver healthy earnings growth, driven by its ability to control cost expenses and grow its top-line aggressively without damaging margins in a significant way. 

With 86% of the company's shares floating in the market, trading at a 2013 P/E of 19 and with a market capitalization of $1.35 billion, I think Elizabeth Arden is a great alternative if you are looking to get exposure to the growing cosmetics market. Although the company does not pay any dividends, it is a good M&A target for many bigger competitors such as Estee Lauder.

Betting on Asia

Even if top-line growth is now stalled, I expect Shiseido (NASDAQOTH: SSDOY.PK) to grow its operating profit by 59% year-over-year by 2014. The main reason for its slow growth is that the business in Japan (where the company is based and generates over 50% of its sales) is almost completely stalled. 

Meanwhile, Shiseido's overseas business is growing. The company projects China sales year-over-year growth of 6% to 9%. Besides, Shiseido's first-quarter shipments were strong. In Europe, the fragrance business has slowed since the first quarter and Shiseido expects a decline in sales for the region so investors should focus at what might happen in China.

The risks of investing in this $5.9 billion market capitalization Japanese company are many: (1) unknown domestic brand strategy and a review of sales channels, (2) unknown Chinese business growth, and (3) the announcement (or not) of radical cost-cutting programs. 

Following the recent announcement of a $290 million goodwill impairment loss on Bare Escentuals (acquired in March 2010), we need to look at 2014 estimates to value the business. Shiseido now trades at a 2014 P/E of 25, which is expensive unless the company successfully cuts costs and the Chinese side of the business revives strongly. Given that the yen is being depreciated by the Japanese central bank, it would be natural to expect costs going down sharply in US dollars and a recovery in international sales thanks to the better U.S. pricing of Shiseidos's products.

The bottom line

The three companies named above operate in a business that is growing fast in emerging markets. While Estee Lauder is much more concentrated in premium brands, Shiseido and Elizabeth Arden are generalists. That said, Shiseido's market is more concentrated in Asia and its fate depends heavily on that part of the world. Meanwhile, Elizabeth Arden is a truly global cosmetics company focused on premium and non-premium brands. The company not only trades at a fair level, but also could be a good M&A target going forward given its market capitalization. 

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Federico Zaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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