L'Oréal, too chinese for comfort?

The unprecedented pandemic definitely turned majors into stronger firms and mid-weights into weaker ones. L’Oréal jointly with French luxury stocks (encapsulated under the Khôl* moniker by AlphaValue) have become safe-havens for investors in this disrupted environment thanks to their impressive resilience due to Chinese consumers.

We continue to believe that L'Oréal, with its greater penetration in the Chinese market, its industry-leading online adoption and its absolute leadership in the booming dermo-cosmetics sector, will continue to set new records in the post-pandemic world.

However, the promising Chinese beauty market is a double-edged sword.

Digital fond de teint

Thanks to its stupefying penetration in the Chinese market (a more than 25-year effort), L'Oréal has become the absolute digital pioneer in the industry. After several years of collaboration with Alibaba, China's largest e-commerce giant, L’Oréal has become the No.1 beauty group in the Chinese e-commerce market, topping the Double 11 shopping event for several consecutive years. Although Lancôme's throne was taken over by Estée Lauder in 2020, five of the top 15 Tmall 11.11 beauty brands were from the L'Oréal sales, with total group sales largely dominating.

L’Oréal’s online business splits into direct-ecommerce (own websites), e-retailer (e-commerce platforms) and partner retailers (multiple-channels retailers, such as Sephora). China is L'Oréal's largest online market, with online penetration exceeding 50%. Compared to China and the US, e-commerce penetration in Europe remains limited (high single-digits). The pandemic-driven structural shift from offline to online has resulted in an unprecedented increase in the adoption of online business worldwide, allowing the group to replicate the experience gained in the Chinese market outside China, that is in Europe. The group's online business grew from 16% to 27% of total sales in 2020, and continued to grow at 47% in Q1 21. Increasing geographic diversification will make the group's online business more resilient.

China + skincare sums it up

With the rapid growth of the Chinese economy, cosmetics consumption is increasing rapidly. As illustrated by the chart, the size of China's cosmetics market has been growing steadily since 2015. Although the pandemic had a significant impact on the overall retail industry in 2020, the cosmetics market recovered quickly in the second half of 2020, especially with the boost from the "Double.11", "Double.12" shopping events at the end of the year, the full-year growth remained in line with the average. Total cosmetics retail sales in China are expected to exceed €55bn by 2023.

The strong momentum in the Chinese market has enabled the group's APAC business to overtake Western Europe as the group's largest one since 2019.

In particular, due to the increase in the average age of key consumer groups, worsening air pollution, Asian consumers' obsession with sunscreen, anti-ageing and whitening products have been increasing significantly, turning skincare products into the driver of cosmetics market.

Skincare accounts for more than half of the Chinese cosmetics industry. When the cosmetics industry was hit by the pandemic in 2020, Skincare was also the fastest rebounding category.

L’Oréal’s quarterly figures show that the L’Oréal Luxe and Active cosmetics segments, which have a greater exposure to skincare products, clearly outperformed the Consumer products segment (make-up accounts for 30% of the division). Underlining the strong resilience of Active cosmetics, the division not only benefited from the opening of pharmacies and essential shops, even during the worst of the lockdowns, but also because the more demanded skincare and sun protection products cover almost the entire dermo-cosmetics business.

Interestingly, although the Chinese cosmetics market is already L'Oréal's cash cow, there is still plenty of headroom for further growth. The Chinese cosmetics market has overtaken that of Japan as the world's second largest cosmetics one since 2013. However, Chinese consumers' per capita spending on skincare and make-up is still well below the global average. Compared to more mature countries like the US, Japan and South Korea, the upside is still 5-7 times...

Treading on eggs

China-driven groups, such as L'Oréal and luxury groups, are beginning to realise that this piece of cake called "Chinese consumers" is getting so big that the increased dependence also has risks. First of all, in the first chart above, we can remark that there are three local Chinese brands in the "Tmall top 15 beauty brands". As a reminder, the Chinese beauty market has long been dominated by international brands, led by the L'Oréal group brands (Lancôme and L’Oréal Paris). However, the boom of e-commerce in China has lowered the barriers to brand building and marketing. With a better understanding of local consumers and a strict focus on product quality, local brands are starting to be accepted by young consumers. In recent years, the political friction between China and the Western world has led young consumers to opt to be more patriotic, which has also encouraged the consumption of local brands.

In addition to the threat of local brands, the Chinese market is another world, another political act that conflicts potential with business interest. The boycott of H&M by Chinese consumers over XinJiang cotton is still a hot topic on Chinese social media. Even the world's second largest fast-fashion brand has capitulated to the anger of Chinese consumers and e-commerce giants. This is a lesson for other western brands.

Dear L’Oréal

As mentioned above, L'Oréal's share price today is seeing us struggling to uncover extra upside. To reflect our conviction on the group’s fast-growing skincare business, we have reviewed our SOTP valuation. We have applied EV/sales multiples of 8x to the skincare business to highlight Chinese consumers’ strong appetites for Skincare and dermo-cosmetics product, which still leaves limited upside. We have no doubt that the pandemic's successive storms turned L'Oréal into an even stronger firm. The recent gradual relaxation of social restrictions (end of compulsory masking) in several countries will even give more oxygen to the beauty industry. However, the Chinese dependence must impact the risk perception for the beauty giant's long-term path.

Access to fundamental analysis on l'Oréal : click here

*Kerin, Hermes, L'Oréal, LVMH.