The market isn’t famous for having empathy. Instead, it’s a brutal place that can send you on a spectacular emotional rollercoaster ride in the space of a single day. With Estée Lauder dropping 20% in the past week, mascara is running down the faces of investors and the share price chart is a deeper red than any shade of lipstick over most time periods. The stock is trading at the same levels we saw in 2013!
The messenger of misery visited practically the entire beauty industry in the past week, claiming scalps beyond Estée Lauder’s. Ulta Beauty is the stock that people most commonly refer to when looking at this sector and that share price is down nearly 13% year to date, taking the 12-month drop to 28%. If we apply a longer-term lens of five years (which gives us a base for comparison just before the March 2020 Covid crash), the compound annual growth rate is just 4.8%. That’s poor.
In its earnings call in early December, Ulta revealed sales growth of just 1.7% and tepid earnings per share growth of 1.4% in the latest quarter. All it could manage was to maintain market share as it faced a barrage of competition.
Let’s face it: barriers to entry are low in this space. Ulta might use tactics such as loyalty programmes and exclusive brand partnerships to drive traffic, but that’s not enough to create a strong moat. Cosmetics are easy to transport and have long shelf lives, so the usual retail strengths of supply chain and distribution just don’t apply here. Someone with a few hundred thousand Instagram followers and an affiliate code with an online store can do a pretty good job of selling these products.
Digging deeper into Ulta’s numbers reveals a fascinating trend that was present before the festive season: while skincare and fragrances were delivering reasonable growth, the makeup category was firmly in the red and so was hair care. It seems that the more specialist categories are delivering all the growth, with everyday purchases under pressure. It’s not as though people aren’t washing their hair as often, so this points to the increase in competition.
Of course, one of the competitive forces and perhaps the scariest of all for Ulta Beauty is Sephora, the beauty retail brand in LVMH. In the latest LVMH letter to shareholders, the performance at Sephora was described as “remarkable” — and that’s great news for LVMH investors who understand that Sephora is one of the group’s primary growth engines. Ulta finds itself up against Sephora at the premium end of the market and a long tail of competitors at the other end, without forgetting the impact of the likes of Amazon.
Here’s the key difference to the South African market: Ulta Beauty isn’t a pharmacy group that can use the dispensary to drive foot count. It is entirely reliant on shoppers going to the store for beauty products. Locally, Clicks and Dis-Chem can attract shoppers who visit to get their medicine, with the real money made in the “front shop” on their way out the door. But in the US, even adding dispensary services to the beauty offering is no guarantee of success.
It would be silly to ignore the trends in developed markets and assume they could never happen here
Walgreens Boots Alliance (a business model you’ll recognise based on similarity to Clicks) is in the midst of a difficult turnaround, with such challenges as online pharmacy offerings having hurt it. Yes, there are other problems, such as the way pharmacy benefit managers operate in the US market, but it’s clear that South African pharmacy and beauty retailers are enjoying far more favourable conditions than the US equivalents. If you’re looking at a consumer business in the US market, there’s a good chance it has a dartboard with Amazon’s logo in the middle. The impact of Amazon in the US market is poorly understood in South Africa as we have nothing close to that level of online sales adoption.
Could this change? Of course! It would be silly to ignore the trends in developed markets and assume they could never happen here. With Clicks on a p:e of nearly 30 and Dis-Chem on almost 28, local investors are banking on little or no disruption in this space. Once upon a time, people thought the same thing about Ulta Beauty and Walgreens. South African consumer behaviour won’t change overnight, but don’t underestimate how much it might change over the next decade. The key metric to watch is online sales and especially any meaningful adoption of online pharmacy services in South Africa.
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