Date February 2019
- Standalone retailers Ulta and Sephora continue to dominate the retail cosmetics industry with a combined 37% market share
- Moderate beauty business is on the rise, with stores like CVS and Walgreens, and even dollar stores expanding their cosmetics inventory
- Clean and cruelty-free beauty products continue to increase in popularity, with the potential to drive down demand for product lines utilizing potentially harmful ingredients and engaging in animal testing
Approximate net recovery on cost
The push for inclusivity drives industry change: Rihanna’s Fenty Beauty line debuted in late 2017 and has had a broader impact on the cosmetics world to date. Gaining popularity for its precedent-setting wide range of shades for all skin tones, Fenty pushed competitors to keep up in 2018. The equation was seemingly simple – the more shades available, the broader the range and number of consumers who buy the product, and therefore the more profit – yet it had never been done to this extent. Over the course of 2018, high-end cosmetics companies Nars and Marc Jacobs were among several other brands to broaden their product lines, offering foundation in 30-plus shades. The notion that darker-toned shades are less likely to sell was quickly put to rest after the popularity of these colors was highlighted by Fenty Beauty quickly selling out of its darkest shades soon after the release of the product line. Appealing to forward-thinking millennials is a wise move for cosmetics retailers; according to TABS Analytics, women ages 18 to 34 are the heaviest buyers of beauty products.
In conjunction with a push for diversity, clean and green beauty has continued its popularity, and wellness-focused and environmentally conscious buyers are favoring products made with all organic ingredients that are not tested on animals. In order to keep up with demand, retailers have included greener products with less toxic components, with some brands like Juice Beauty and Josie Maran introducing entire lines of eco-friendly and cruelty-free products. Given the growing trend toward cleaner, organic, and non-toxic products and their increasing availability to a larger customer base, companies that continue to manufacture products that include petroleum-based or higher toxicity ingredients and engage in animal testing may experience a downturn in sales over time, possibly resulting in lower gross recoveries as these products becomes less desirable to consumers.
Department and drug stores ramp up competition: As a range of companies attempt to compete with industry giants Sephora and Ulta, department and drug store retailers have revamped their cosmetics departments in order to capitalize on beauty, cosmetic, and fragrance growth, which IBISWorld reports has been positive for the past 10 years. Ulta’s third quarter 2018 sales increased over 16 percent, reflecting the addition of 105 stores since 2017, as well as a 7.8 percent increase in comparable store sales. E-commerce sales also increased to 11 percent of revenue, up from 10 percent for the same period in 2017. Sephora had another year of growth as part of its parent company’s cosmetics and fragrances division, which generated increased profit from recurring operations of 13 percent for 2018. The company noted that Sephora strengthened its positions in all markets and in digital via successful product collections including Fresh and Fenty Beauty by Rihanna, among others.
While Ulta and Sephora continue to dominate, generating a combined 37 percent of industry sales, in an effort to grab additional share of the mid-range beauty business, CVS recently gave its beauty departments a makeover, doubling them in size and offering services by beauty group Glamsquad. In October 2018, competitor Walgreens announced a partnership with Birchbox, to allow customers to “build your own Birchbox” in stores. The program was set to launch in 11 Walgreens stores in late 2018 and into 2019. The strategy will allow Birchbox expand its pure-play platform and extend brand recognition to a much bigger audience. The dedicated Birchbox spaces will run separate from Walgreens typical beauty aisle, with “elevated design” and fairly large areas ranging between 400 and 1000 square feet. CVS and Walgreens had a combined market share of 48.8 percent of U.S. health and beauty retail in 2018 according to CoreSight Research, and will likely see similar, if not higher, numbers going forward, as planned inventory expansions roll out.
There are a few exceptions to the upward trend, however. Kansas City-based Beauty Brands filed for bankruptcy in January 2019 and announced the closing of 23 stores while the company pursues a going concern sale of its remaining 33 stores. Additionally, Sally Beauty Supply, which controls approximately 7.5 percent of industry market share, plans to close as many as 100 stores in the United States and abroad in the next year and has also launched a buy-online-pickup-in-store program as part of its long-term transformation strategy. The company has struggled to compete with Amazon and Ulta, as well as department stores. Fourth quarter 2018 revenue decreased 0.8 percent, reflecting a 0.2% decline in comps, which was partially offset by the opening of six stores (net) over the course of the year.
Social media enhances beauty “experience”: The increasing popularity of beauty bloggers and social influencers has helped drive the popularity of certain brands, particularly ones that are willing to pair with influencers on advertising deals. The wellness trend has continued to gain popularity, resulting in a surge of demand for products like beauty supplements and skincare products, many of which are promoted by celebrities on social media. Glossier, which was named the fastest growing startup in 2017, has relied heavily on endorsements from YouTube beauty vloggers and sponsored content on Facebook and Instagram. The company looks to be a brand that listens to its customers and “lets shoppers evolve the brand narrative and purpose” according to information published by Retail Dive.
Special liquidation considerations for cosmetics and fragrances: For asset-based lenders considering cosmetics and fragrance inventory as collateral, it is important to understand how these products would recover in a liquidation event and what additional considerations may be required. Fragrance inventory can achieve strong gross recoveries in a liquidation depending upon brand name and customer demand; however, this inventory may be consigned and therefore potentially not eligible on the borrowing base. Similarly, branded, high-end cosmetics are typically a high gross recovery category in a liquidation, as there is generally not a significant amount of normal-course discounting on these products.
Gordon Brothers typically considers branded cosmetics inventory from industry leaders such as Estée Lauder, Lancôme, and Clinique within its appraisal net recovery analysis. It is important to note, however, that in a going-out-of-business (GOB) event, select vendors may elect to re-purchase their inventory from the retailer at 70 to 100 percent of cost to protect their products from being heavily discounted, which could potentially result in the erosion of brand perception in the marketplace. In some cases, branded cosmetics have been retained and sold in liquidation sales at discounted rates. For the purposes of an appraisal analysis, Gordon Brothers typically assumes all cosmetics would be included in the GOB sale; thus, gross and net recovery rates include the proceeds and related expenses to liquidate the total inventory. It is important for lenders to partner with appraisers to understand the implications of situations in which a retailer, agent, or liquidator may negotiate an agreement whereby the vendors re-purchase inventory and to understand what the net outcome of such an agreement may yield.