The share price of Revlon (REV) had kept climbing since September 2018, driven by the significant growth of operating income in the second half of 2018. However, REV's share price started to drop since March 2019. What are the main factors that are driving the price decline? Going forward, does REV have enough competitive advantages to sustain its business growth?
REV owns brands including Revlon, Elizabeth Arden, Almay, American Crew, CND, and Mitchum. Among them, Elizabeth Arden is the premier skincare brand offering products including Ceramide and Prevage, while Revlon offers drugstore cosmetic products at a more affordable price.
As we can see from the following graph, in 2018, Elizabeth Arden is the only segment that saw growth in sales compared to 2017. The net sales of Elizabeth Arden went up by 13%, while Revlon's sales declined by 9%. In terms of profitability, Elizabeth Arden's profits went up by 253%, while Revlon's dropped by 29%. This shows that besides net sales, the profit margin for Elizabeth Arden has also increased greatly in 2018.
Source: Revlon 10-K
On one hand, Revlon's slowdown in performance shows the increasingly fierce competition among drugstore makeup brands. Revlon's strongest advantages are its low price, high quality, and profound history in the cosmetics industry. However, nowadays brands like Maybelline and ColourPop are able to offer products with good quality and yet lower price.
On the other hand, the outstanding performance of Elizabeth Arden indicates several important trends in the makeup industry. First, Elizabeth Arden saw particularly strong growth in the Chinese market. REV's net sales in China were up 54% in the second half of 2018. Since Revlon is not in the mainland market, Elizabeth Arden contributed to the overwhelming majority of China's sales growth. Second, in terms of the sales channel, travel retail and e-commerce have become the strongest growth engines. In 2018 Singles' Day in China, REV grew net sales approximately 90% over the prior year. It also had an extremely successful Black Friday in the US, during which REV grew net sales 154% relative to 2017.
Business in China
Going forward, the most important issue is, is the growth momentum of REV able to sustain?
Elizabeth Arden's success shows the extreme importance of the Chinese market for business expansion when most of the consumer goods sectors are already saturated in the United States. However, the ongoing geopolitical events and a potential slowdown in China's economy make REV's outlook less uncertain.
The biggest and most obvious challenge is China's retaliatory tariff against the United States. China has struck back in the escalating trade war by imposing tariffs of up to 25% on US goods including cosmetics, fragrances, and makeup ingredients like mica powder and zinc oxide. At the current tax rate, American beauty brands like REV face high risks of losing their market share as the increased tariff burden may incentivize many Chinese consumers to shift to local brands or brands from South Korea, Japan or Europe.
According to the China Cosmetics Market Report, China is currently the world's second largest cosmetics market after the US. At the same time, the competitive landscape of the cosmetics market in China is also changing. Domestic skincare brands like Proya Cosmetics and Aupres are becoming increasingly popular, which further threatens the market share of Western high-end products like Elizabeth Arden.
One interesting fact is that, in the first quarter of 2019, Elizabeth Arden achieved a yoy growth rate of 26% in segment profit, while Revlon reached a growth rate of 1,000% in its profit. The drastic increase in Revlon's profitability is very likely due to cost cuts in sales and marketing.
Source: 2019 10-Q
REV has been reporting negative earnings since 2016, and that is not likely to change anytime soon. The management has taken multiple measures including boosting performance in China and cutting costs to improve its profits, and those measures have been taking effect. However, the cost-cutting strategy alone is not enough to turn REV's net income into being positive. What's more, REV now faces much more challenges to expand its market share in China due to ongoing geopolitical uncertainties and increased competition.
It is true that REV's financial profitability has significantly improved since the second half of 2018, driven primarily by the strategic focus of Elizabeth Arden products in China and cost-cutting strategies. However, as the business outlook in China becomes more uncertain, REV faces significant risks of sales decline starting in the latter half of 2019. At its current valuation, REV remains a risky investment with its negative earnings. Investors who are interested in the beauty industry have better options to go for, such as Estée Lauder (EL) which has a P/E ratio of 32.01.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.