Japanese beauty needs to look beyond China

Buying into Japanese beauty products groups is a sure fire way to beat the market — or at least it was a decade ago. In the six years to 2018, investors in industry leader Shiseido would have generated around a ninefold return on their investment. The sector came with the added comfort of being low risk, known for its stable growth rates and high margins.

Today the sector is underperforming in a period when the broader market is trading near record highs. Operating margins have yet to recover to pre-pandemic levels. Activist interest is forcing companies to hunt for new sources of growth.

Shares of Shiseido are down 30 per cent in the past year, underperforming the benchmark Nikkei 225’s 30 per cent rally during the same period. Smaller peer Kao has barely matched the Nikkei’s gains.

That reflects weak earnings in China, a key market for Japanese beauty groups, and an even bleaker outlook. Kao’s net profit has fallen for the fifth straight year for the year to December. For Shiseido, which reported a 40 per cent slide in its latest annual earnings, China is its biggest market, accounting for 24 per cent of total sales.

The economic recovery following the pandemic has been slow. Unemployment among 16-to-24-year-olds, which remains at more than 15 per cent after hitting a record-high 21.3 per cent last June, has depressed consumer spending. Make-up has been quick to drop off shopping lists. That decline has been exacerbated by Chinese boycotts in protest against Tokyo’s decision to release treated water from a damaged nuclear reactor.

Longer term, the problem is that even once an economic recovery in China picks up, Japanese brands’ pre-pandemic share of local spending may not return. Chinese shoppers have been increasingly turning to homegrown beauty brands, with sales growing rapidly to account for about half of the local $80bn beauty and personal care market. Exports of Chinese cosmetics and personal care products started to grow too last year.

Falling earnings and share prices have attracted activist attention, including from Hong Kong investment firm Oasis Management, which currently holds more than 3 per cent of Kao shares. Oasis is considering submitting shareholder proposals to Kao next year to boost shareholder returns, which explains a rebound in the stock in the past month.

A longer term recovery would require diversifying beyond its key Chinese market, expanding market share in regions such as the Americas, which currently stands at just over a tenth of group sales. Getting a new international look, however, is no mean feat in beauty.

june.yoon@ft.com