Revenues: EL’s Asia Pacific (China is the bulk of it) Revenues have grown at
a CAGR of 14% over the last three years (ending June 22) in spite of it being
flat in TTM due to covid lockdowns in China. Pre-pandemic they were growing in
the 20-25% range YoY. A lot of luxury brands had been slow to move online
pre-covid as they always wanted to maintain that exclusivity and a certain
level of scarcity; selling on Amazon is not exactly exclusive and hence even
during as well as post-covid it doesn’t sell on Amazon. So, they suffered
from Covid and are likely to benefit more as lockdowns end in China (for
China-driven luxury sales brands). Clearly, EL has grown in China and we will
discuss some of the reasons as well as the risks associated with it below.
Organizational Structure: EL has created an (almost) second headquarters in
China. Most other luxury brands would typically have a creative director
sitting in New York or their HQ and they would design products that are sold
worldwide. EL on the other hand has hired a creative director in China, that
would create localized products that would celebrate specific Chinese
traditions. EL does have very solid boots on the ground and 99% of the team in
China is Chinese, and they have an R&D center in Shanghai to develop
localized products. Moreover, they also changed the reporting lines internally
so that the Head of China reports to the corporate directly in New York (HQ)
versus going through the APAC region (norm in the past) essentially giving
China its own regional status equivalent to say EMEA and seat at the table
equivalent other regional heads reporting into corporate at NY.
Product Management: Localization in product management is all the more
important in Asian markets. For example, in EL’s core skin care (bulk of the EBIT)
category: In Western countries,
most consumers have a preference for something that’s very simple; they’re not
looking for ten-step skin care regimens. They just want a few core
products such as a cleanser, toner, moisturizer, eye cream and a serum.
Even within these moisturizer & serum would be the lion’s share of sales. In
the Asian markets, and China similarly, multistep skin care regimens are the
norm. It’s not unusual to see 10 to 15 steps. Apart from the core western
products, additional products (steps) involved in Asian skin care regimen are
brightening products (used to even skin tone), masks (used for prep) and sunscreen.
Management: Fabrizio Freda is a transformational CEO, he joined EL in 2008
as COO & was named CEO in 2009; he worked at P&G since 1982 before
joining EL. He was able to bring a more commercial perspective to a luxury
company that sometimes gets so bogged down in the creative process that they miss out
on the commercial piece. He has that commercial mentality that sometimes is
lacking at luxury companies; he understands that sales are the end goal, and
doesn’t want EL to be just a sort of coveted and high-end luxury brand.
Operating margins at EL have increased over the last three years (June ending),
in spite of the Covid lockdown and sales slowdown, from 16.3% in FY19 (June
end) to 17% in FY22 (June end). EPS has increased at a CAGR of 10% for the last
three years (ending June 222).
Risks: Some of risks associated with selling in the China market are:
A)
Chinese consumers on nationalism & buy local trend.
It used to be that the Chinese actually did not want Chinese nationalist brands
because there was this perception of lesser quality and that has really changed
with the success of local luxury brands such as Perfect Diary. However, not
many brands have been able to break through in APAC because of the structure of
the market, it is very much pay to play and brands have to put in lots of
marketing dollars with big retailers like Tmall, Alibaba, etc. So, it is hard
to break through as a tiny brand without lots of backing and funding. Moreover,
brands such as Perfect Diary are still in the accessible luxury segment while
EL offers prestige & ultra-luxury products.
Animal testing: This
is more of a rest of the world issue. Any beauty brand selling in China has to subject
its products to animal testing before they are approved for sales in the country;
this is a huge negative for brands also selling in other western countries
where consumers are strictly against animal testing. As of now brands skirt
that issue by claiming they don’t do any animal testing since the tests are physically
conducted by Chinese govt. authorities and so it’s a gray area; brands still
have to order animal testing for product
approval.