Elevator Pitch

I award a Buy investment rating to Yatsen Holding Limited (NYSE:YSG).

Company Description

In its media releases, YSG calls itself a “China-based beauty” business that owns multiple “color cosmetics and skincare brands” like its “flagship brand, Perfect Diary”, which is among “the leading color cosmetics brands in China in terms of retail sales value.”

Yatsen’s Key Color Cosmetic Brands At A Glance

An Overview Of YSG’s Main Skincare Brands

The color cosmetics brands and the skincare brands accounted for 68.3% and 31.7% of Yatsen’s top line, respectively for most recent quarter as disclosed in its Q1 2024 results release. I will be primarily focusing on YSG’s color cosmetics business for the purpose of this write-up. This is because the color cosmetics brands contribute more than two-thirds of the company’s latest first quarter revenue, and Perfect Diary is a prominent color cosmetics brand in China.

YSG’s Perfect Diary Brand Of Lipstick Products Are Bestsellers In China

Latest Industry Sales Data Have Favorable Read-Throughs For YSG’s 2024 Performance

Cosmetics sales in China grew strongly by +18.7% YoY to RMB40.6 million in May 2024, according to National Bureau of Statistics of China’s most recent retail sales data release (translated using Google) on June 17. As a comparison, Mainland China’s cosmetics sales contracted by -2.7% YoY to RMB27.8 billion for April this year.

On a year-to-date basis, cosmetics sales for the Mainland Chinese market increased by +5.4% YoY to RMB176.3 billion in the first five months of the current year. In comparison, the current sell side consensus full-year FY 2024 revenue growth projection for Yatsen is +6.4%.

The recent industry sales figures suggest that there is a good chance of YSG meeting or even exceeding the analysts’ expectations regarding top line expansion this year.

The robust cosmetics industry sales numbers for May are an indication that cosmetics products were well received at China’s key retail event, the 618 shopping festival, which began on May 20 and concluded on June 18.

Chinese beauty industry research firm Chaileedo referred to the 618 shopping festival as “an indicator of brand confidence for the second half of the year” in its June 19, 2024 commentary piece. As per data taken from Chaileedo, the growth in beauty product sales on Alibaba’s (BABA) Tmall e-commerce platform accelerated from +41% for April 2024 to +69% in May this year thanks to the healthy demand for beauty products at the 618 shopping event. This bodes well for Yatsen’s Q2 2024 and full-year 2024 top line performance.

Separately, YSG’s key Perfect Diary brand could outperform the overall beauty or cosmetics industry for the current year thanks to its new product offering.

A Brief Description Of Yatsen’s Biolip Technology

At its Q1 2024 results briefing in late May, Yatsen highlighted that its new offering, “Biolip Essence Matte Lipstick launched earlier this year” achieved “a good performance during the March 8 Shopping Festival.” This new product is developed based on the company’s Biolip technology, which has unique characteristics as per the chart presented above.

In a nutshell, YSG’s FY 2024 outlook is favorable, taking into consideration the recent industry sales numbers.

Industry Consolidation And R&D Investments Will Be Yatsen’s Key Long-Term Growth Drivers

In YSG’s fiscal 2023 investor presentation slides, the company revealed that its “Perfect Diary (brand) has been gaining market share in the lipstick category on both Tmall and Douyin (Chinese short-form video platform).”

I take the view that industry consolidation and the company’s focus on research & development or R&D will allow Yatsen and its key brands to grab share away from rivals in the years ahead.

Mainland Chinese stockbroker Guotai Junan Securities recently issued its mid-year 2024 cosmetics industry outlook research report (not publicly available) on June 13, 2024. In its report, Guotai Junan Securities mentioned that the 20 largest cosmetics brands in China saw their aggregate sales increase by +39% YoY in the 5M 2024 time frame. On the other hand, the other smaller cosmetics brands (all brands except the 100 largest players) for the Mainland Chinese market as a whole witnessed a -2% contraction in sales for the same time frame. In other words, there is a clear trend of bigger brands gaining share at the expense of smaller brands, and this is positive for Yatsen and its Perfect Diary brand.

On the other hand, YSG’s relatively larger size by virtue of having a leading brand like Perfect Diary gives it the capacity to invest more in R&D.

As a reference, Yatsen’s R&D costs-to-sales ratio increased from 1.3% in FY 2020 and 2.4% in FY 2021 to 3.4% and 3.3% for FY 2022 and FY 2023, respectively as indicated in its FY 2023 investor presentation. The increase in investments pertaining to the development of new offerings puts YSG in a better position to win over more consumers.

Market leaders like YSG continue to expand their revenue base, which allows them to allocate a growing amount of monies to new product investments. In contrast, sub-scale players in the cosmetics industry will likely experience declining sales and market share loss, and this limits the amount of capital that can be devoted to R&D.

In summary, Yatsen’s long-term growth prospects are favorable, as the company is well-positioned to gain market share with industry consolidation and new products supported by R&D investments.

Risk Factors

The key risks for YSG relate to consumer sentiment and new products.

Assuming that Chinese consumer sentiment weakens, Yatsen’s actual sales might come in below expectations as people in the country cut back on spending.

Also, it is important that YSG continue to roll out new products that find favor with consumers. Yatsen’s key brands might lose their appeal over time if the new offerings fail to gain traction.

Closing Thoughts

Yatsen’s outlook for the short-term and long-term is positive, as detailed in this article. More importantly, the stock’s valuations are attractive in absolute terms and as compared to its peer. YSG is now trading at a low-single digit or 2.0 times consensus next twelve months’ EV/EBITDA based on S&P Capital IQ data. As a comparison, Shanghai Jahwa [600315:CH], Yatsen’s China beauty business peer, is currently valued by the market at a consensus next twelve months’ EV/EBITDA ratio of 12.3 times.