Cheap Valuations Prompt Investors Like Warren Buffett to Buy Beauty Stocks Despite Concerns Over Industry Prospects

Beauty brands often showcase resilience during market downturns. When budgets become strained, especially during recessions, people refuse to give up on smaller luxuries like beauty and skincare products. The trend of splurging money on beauty and affordable luxuries when cash is tight and the economy is weak was theorised as the "lipstick index."

However, the index is under pressure to retain its long-term reliability. The recent market downturn impacted shares of beauty giants like Estee Lauder and L'Oreal as cosmetics and lipstick sales slumped with the overall economy. Despite the divergence, it didn't deter Berkshire Hathaway chairman Warren Buffett from buying over 690,000 shares of cosmetics brand Ulta Beauty for $266.29 million in Q2. The Oracle of Omaha believes the purchase was a value buy as the beauty industry undergoes new changes, implying that the ongoing upheaval isn't a long-term trend.

Beauty brands are increasingly transitioning from phrases like "anti-ageing" to terms like "renewal." However, the shift might not resonate with younger generations seeking real solutions to acne and wrinkles. Meanwhile, the skincare industry is also witnessing a change in how dermatology products are portrayed. For instance, moisturisers are marketed more as pharma products than skin lotions. Despite the global cosmetics industry slump, sales haven't faltered in all markets. Buffett believes in buying great companies at reasonable prices, and the current cosmetics market slump could offer a window for investors to scoop up shares of beauty brands at huge bargains.

Estée Lauder

Leonard Lauder coined the "lipstick index" term in 2001. He was then chairman of the Estée Lauder group of companies, which his mother founded in 1946. However, the $30.32 billion beauty empire's overdependence on the index could be the root of many of its business concerns. The company's stock price tanked over 70% since early March to close at $84.52 on September 11, which can be attributed to its FY 2024 net sales decline to $15.61 billion due to weakness in mainland China's overall prestige beauty market.

Estée Lauder assumed that sales from its Chinese customers would remain unchanged despite negative economic factors like high youth unemployment and the prolonged real estate slump. Customers in China account for one-third of company sales. Furthermore, the US-based cosmetics giant lagged in efficiently promoting its brands like Clinique, Tom Ford, and Mac on social media platforms. Its transition away from failing department stores to outlets like Louis Vuitton Moët Hennessy's Sephora also slowed down. The series of challenges on multiple fronts pose a major problem for CEO Fabrizio Freda, who will step down in 2025. While several analysts maintained a "hold" rating on the stock, Rathbones' David Coombs believes "any recovery in China should result in a decent bounce." He also highlighted the company's growing sales via Amazon, which is increasingly becoming a one-stop-shop for beauty products globally.

L'Oreal

France-headquartered L'Oreal is the world's biggest beauty brand, with a market cap of $218.48 billion. Company management, led by CEO Nicolas Hieronimus, steered the company better than rival Estée Lauder to navigate the China slump. Meanwhile, L'Oreal, which owns brands like Garnier, Maybelline, Aesop, and Keihl's, also improved its market share in the dermatology sector with SkinCeuticals and Cerave brands. It also bought a stake in Galderma, which provides injectables like Botox.

Sales on more expensive offerings have dipped due to faltering demand amid high living costs and elevated inflation, which dragged down L'Oreal stock price by over 18% year-to-date (YTD) to above €368 ($405.35) on September 12. However, analysts think the "narrative is now too negative," given that L'Oreal is among the so-called "Granolas," often described as European stocks favoured by US banks seeking bargains. Brokerages like Bernstein retained a stock target price of €490 per share. The positive outlook could be driven by L'Oreal prioritising its perfume business, which is supported by long-term contracts with couture houses and advertising boost from global artists. The company leveraging e-commerce platforms amid the slump has helped it retain positive sales growth rates in 2023 as revenues reached €41.18 billion, where €11.2 billion came from e-commerce channels. Moreover, strong performance from the skincare and fragrances segments also helped increase operating profit by 9.2% year-over-year (YoY) to €8.14 billion. L'Oreal continued to announce over 10% dividend growth while remaining on track to transition to 100% biobased products and renewable energy by the decade-end, which can prove to be a significant market edge.

Elf Beauty

US-based Elf Beauty, where Elf stands for Eyes, Lips, Face, is a famous cosmetics brand known for its affordable makeup and skincare products that have the feel of costlier products. However, it has appealed to investors with its meteoric stock price growth of over 700% in the past five years. The rapid growth has simmered as the stock price tanked over 20% this year to $114.08, given the industry slump and the potential headwinds if Donald Trump is reelected. He intends to impose tariffs on US goods imported from China, which is Elf's primary source of lipsticks and other essentials.

Despite the risks, analysts retained a "buy" rating on the stock, possibly implying a window for investors to capitalise on the cheap valuation. The company's net sales jumped 77% YoY for the 12 months ending March 31 to over $1 billion, driven by record sales via e-commerce and retail channels. Elf Beauty's aggressive innovation approach to creating high-end products at relatively lower costs was further evidenced by the acquisition of high-performance skincare brand Naturium last year.

Ulta Beauty

Buffett's recent buy, Ulta Beauty, has witnessed significant growth in recent years, but the cosmetics and skincare brand revealed last quarter that it continues to face stiff competition from Sephora and Amazon. The $17.54 billion company has continued to increase its footprint consistently, with 1,411 stores in the US at the end of Q2. While its quarterly net sales increased marginally to $2.6 billion, the company failed to meet expectations, driving its stock price down by over 24% YTD to $372.3 on September 11. However, the stock has jumped over 12% in the past month, and Buffett's investment could be playing a role in reviving investor sentiment. Analysts also maintained an average target price of $405 per share.

Ulta Beauty recorded over $400 million in cash and equivalents despite the headwinds. It also reiterated its priority of returning value to shareholders by repurchasing over half a million shares in the last quarter. The company expects to complete its $1 billion share buyback plan in the current fiscal year, although it slightly lowered its 2024 sales guidance to $11.2 billion.

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