Cosmetics: The Worst Is Over

The author is an analyst of NH Investment & Securities. She can be reached at mj27@nhqv.com. -- Ed.

In the cosmetics sector, a short-term earnings slowdown looks inevitable due to the impact of Covid-19. While the DFS channel and domestic market will need some time to normalize, we view it as positive that recovery signals are emerging from offline stores and logistics/delivery players in China.

The worst is over

We adhere to a positive rating on the domestic cosmetics industry. Due to the outbreak of Covid-19, production and sales have been damaged both at home and abroad, and as a result, 1Q20 earnings will likely evidence some slowdown. However, with both outdoor and consumption activities starting to return in China, we believe that a Chinese sales recovery is soon to follow. It is estimated that 90% of offline stores in China have resumed business, and logistics/delivery operations are nearing full normalization. While a similar level of recovery may be further off in the domestic case (including for the DFS channel), considering China’s recovery, we expect that 1Q20 will mark the low point.

Fundamentals and direction of domestic firms remain unchanged

Backed by their rising popularity and robust competitiveness, ODMs should continue to see relatively stable earnings. While brand plays will likely need more time to recover at the DFS and domestic channels, steady improvement is anticipated thanks to recovery in China and a shift towards the online arena. Although consumption activity has been damaged by Covid-19, we do not view the outbreak as a fundamental issue weakening the competitiveness of individual players or reducing demand over a longer timeframe. Over the mid/long term, we expect the industry’s growth trajectory to remain intact.

Earnings to inevitably slow in 1Q20, but share price decline looks excessive

By company, Cosmax is enjoying an expansion in online-focused clients and rapid production normalization. With its high exposure to sales in DFS shops and in China, LG H&H is expected to feel some pain but show a relatively rapid recovery. Meanwhile, due to its hefty portion of non-DFS domestic sales, AmorePacific will likely need more time for a full recovery; however, given its recent sharp share price decline, we expect the firm to see a strong share price boost upon earnings recovery.

In light of Covid-19 effects, we have downwardly adjusted our 1Q20 OP estimates for LG H&H and AmorePacific by 42% and 47%, respectively. Even after reflecting expectations for Covid-19-related earnings deterioration, however, we view the recent share price declines of major cosmetics plays as excessive.