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File Image: IOL

Defensive beauty stocks in L’Oréal hold much promise for investors - Old Mutual

By Opinion Time of article published Oct 1, 2020

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Even though the full impact of the coronavirus pandemic is still to be felt, the first half of 2020 has shown the value of investing in well-managed businesses.

A key lesson from the pandemic is that merely operating in a defensive industry is no guarantee of success, as even established brands grapple with staying relevant in fast-moving consumer markets. This is according to Tasneem Samodien, Research Analyst at Old Mutual Wealth Private Client Securities, who says "we don't necessarily consider beauty products to be defensive, yet it's one of our oldest industries."

Samodien says that several beauty brands have endured some of our worst financial crises on record. While it might be too early to assess the impact of the pandemic on this industry, she says that during the 2008/9 Global Financial Crisis (GFC), sales of beauty products grew 1% at a time when retail sales fell more than 10%.

She says this phenomenon can partly be explained by 'the lipstick effect' — when consumers counter-intuitively continue to spend money on small indulgences despite an economic downturn, making beauty companies exceptionally resilient during economic downturns.

However, Samodien warns that despite this advantage, companies that benefit from the lipstick effect can't afford to rest on their laurels. "Radical changes in consumer preferences are likely to challenge even the most robust of companies. One stock that stands out as a potential winner is the world's leading manufacturer L’Oréal, which has shown over its more than 100-year history that it is resilient enough to adapt to changing times.”

One of the group's key strengths is its ability to maintain its relevance through ingenuity. Samodien says this reflects the group's absorptive capacity, which adds to its strong financial position. "Over the past decade, L’Oréal has maintained a net cash position, except in one year, holding more cash and liquid investments on its balance sheet than long-term debt.

"This provides it with absorptive capacity, which is crucial for a company operating in a cyclical industry. What this means is that it's able to finance debt with ease.

"Since 1993, sales have grown an average of 10% above the global beauty and personal care market, except in 2008 due to the global financial crisis," Samodien says. "This consistent performance has solidified the group's market-leading position of around 14% of the global market share."

However, this performance belies the challenges that even the biggest producers face at a time that consumer tastes are changing at break-neck speed. Such is the pace of change that L’Oréal said earlier this year that customer preferences had changed more in the past three to five years than in the previous 30 years.

"Because the group operates four divisions across five beauty categories, this diversification has made up for its inability to identify new trends immediately. Last year, for instance, its Active Cosmetics division captured the growth of skincare sales that accounted for 40% of total global beauty sales, this partially offset underperformance in the make-up division.

"The breadth of their portfolio has, therefore allowed them to consistently outperform and allowed them to be agile in responding to changing consumer trends and navigate crises."

This agility was on display again during the Covid-19 pandemic when L’Oréal converted perfume factories into hand sanitiser plants. "What is evident so far, based on a recent US poll, is that 90% of consumers have said they were sticking to their pre-Covid beauty routines and two-thirds of respondents said that doing so helped reduce stress. By these indications, the larger beauty brands look set to weather the storm relatively well," concludes Samodien.

"The group's historical performance should give investors the confidence that it will be able to remain relevant as its investment in R&D pays dividends into the future."

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