Coming off the heels of a blowout quarter by industry bellwether Estee Lauder (EL), it is worth taking a closer look at the high margin skin care and cosmetics industry and perhaps the affect it will have on the economy in general. While reporting a 14% year over year sales increase in the skin care category, Estee Lauder stated "Skin care sales growth was strong, particularly in view of the 15% growth in the prior year." According to CEO Fabrizio Freda, apart from double digit sales growth in the United States, much of this growth was driven by China. Interestingly enough, China is a region that other skin care companies have had great difficulty in penetrating. For example, privately-held SkinPro, a Florida based maker of anti-aging skin care products, recently reported that their flagship Elite Serum eye treatment was rejected by Chinese authorities as being "too strong". Certainly with the barriers of entry as high as they are in China towards foreign cosmetic brands looking to service the rapidly emerging middle-class, Estee Lauder is set to reap significant rewards going forward.
More evidence of the skin care sector strength came out on August 15, only a day after Estee Lauder reported their earnings. On this morning, publicly traded skin care manufacturer Physicians Formula (FACE) announced that they have agreed to be aquired by private equity firm Swander Pace Capital in a deal valued at $65 million. This represented 15% premium over the previous day's closing price. Coincidentally, this announcement occurred the morning after Physicians Formula reported their second quarter results that included a sharp 25.2% increase in sales versus the same period in the year prior. Physicians Formula also finally swung to a profit in the quarter. In this report, the company noted that the positive net sales growth was driven by an expanded distribution of the skin care line. Clearly skin care sales are on the rise, but what does this indicate for the economy as a whole?
Much has been written about the Lipstick Index, a term coined by Leonard Lauder who is chairman of the board of Estee Lauder. He used the term to describe sales of cosmetics during the recession of the early 2000s. What Lauder noticed is that his company's sales tend to be inversely correlated to the overall state of the economy. The theory is that in times of distress, women substitute cosmetics like lipstick or a wrinkle cream for more expensive clothing and jewelry purchases or even plastic surgery. EyeSerum.com, an industry review journal, recently reported in a research note to subscribers about a growing trend relating to the search for affordable eye cream treatments in comparison to the decline in demand for more expensive surgical procedures designed to treat the same symptoms.
Does all of this mean that the economic health of the nation is in jeopardy? Not really. It is tough to base any economic model on this indicator as lipstick sales have also experienced significant growth during periods of economic prosperity. Accordingly, the cosmetics and skin care business may be more appropriately defined as recession proof rather than as a true contrarian economic indicator. Even Revlon (REV), a cosmetic and skin care company that never seems to do anything right, is managing to increase US sales in a weak economy year over year despite losses on various charges, litigation and currency fluctuations. Its almost as if nobody can lose in this sector. However, one thing is for certain, skin care sales are booming and there is nothing that appears to be able to stop them, including an economic slowdown.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.