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The Toiletries and Cosmetics Industry is a defensive group that typically attracts investors during tough periods. Companies here tend to turn in stable earnings in both good times and bad, thanks to the general population's routine use of their products. Indeed, in a recession, many investors, driven by the lure of steady and predictable earnings, move into defensive names. Conversely, the industry does not excel during economic upswings, when investor interest shifts to other areas that are growing rapidly.

Shelf-Space Challenges

The battle for shelf space in the mature U.S. market is ongoing, and the inefficiencies are many. While innovative products continuously enter the market place, there is always a large existing population of copy cat, or plain indistinguishable, offerings that take up valued space (even though they might claim a low market share) and often confuse the customer. Big companies, with their hefty budgets for advertising and promotional spending, have an advantage and, from time to time, the imbalance of power and the market's inefficiencies prompt a weeding out of weaker brands. Small manufacturers do better by focusing on niches where a high degree of brand loyalty exists.

Product Development

A cyclical retail sector; an increasing reliance on just-in-time inventory; a continued fight for shelf space that requires significant marketing support; a more value-oriented consumer; and the possibility of inroads by private labels are some of the domestic constraints under which this industry operates. However, technological innovation, such as powered wet shaving systems, can make a meaningful impression on a mature marketplace. This demonstrates that consumers are willing to pay a premium for useful new products, as well as the quality associated with well-known brands.

Manufacturers have the power of self-image on their side. As a result, they must constantly improve existing products and communicate the advantages, so that consumers will trade up, despite hefty price differentials. New product activity, when at an impressive level, boosts volume and margins, and helps to ensure a richer mix. Moreover, demographics indicate that there are opportunities for growth. Notably, the graying of the baby-boom generation augurs well for product demand in the skin-care category.

All Around the World

One crucial factor for the industry is the opportunity to build business in emerging markets, where per capita incomes are increasing, local goods are typically of poor quality, and the usage of personal care items (taken for granted in the Western world) is still sporadic. A number of multinationals have tapped into countries, such as China, India, and Russia, where they can also benefit from a gradual trading up among the population to evermore sophisticated (and high-margined) offerings. Nevertheless, there are hurdles and risks to overcome, such as volatile currency markets and cultural differences, but these seem insignificant in comparison to the sales and earnings potential afforded to companies.

Is Brand Loyalty Dead?

We do not think so, at least where toiletries and cosmetics are concerned, though it is true that one of the most significant currents to make an imprint in this sector is the consumer's emphasis on value. To the uninitiated, that would seem to suggest that price is the primary consideration in a purchase decision, but that is just not the case. Price is certainly a factor that carries a lot of weight, but consumers have become more knowledgeable about product content/effectiveness, and they are more concerned about receiving value for their money than buying cheap.

If manufacturers can demonstrate their product provides advantages over rival offerings, consumers are willing to pay up. Given the large number of products on the market in any one category, though, two important differentiating factors that come to light are technological expertise, with regard to product development and distribution, and a marketing budget large enough to ensure product differences are communicated to the public. This fact, which really does not augur well for small companies, suggests that there will be further consolidation.

Change

Although many exclusive cosmetic brands are only available in upscale department stores, distribution patterns have changed. Notably, high-growth distribution channels, such as the Internet, infomercials, television home shopping, and independent retailers and spas, have made their mark, and traditional brands are taking advantage of these avenues to boost top-line growth. Notably, one well-known company has used high-tech vending machines in airports.

Separately, the fastest-growing sectors of the industry include dermatological skin care, men's personal care, and products designed for ethnic groups. As a result, it comes as no surprise that many companies focus their research and development, as well as advertising dollars, on market niches that offer impressive growth.

Strong Cash Flow

The combined effects of earnings stability, modest debt-service responsibilities, and low capital spending requirements add up to solid, and growing, cash flow, which can be used to support acquisitions, repurchase common stock and/or increase the dividend. Strong cash flow often leads to enhanced shareholder value.