Kose: Initiating Coverage of This Narrow-Moat-Rated, Japanese, Prestige Beauty Player

We initiate coverage of Kose 4922, the third-largest Japanese cosmetics company by sales, with a fair value estimate of JPY 12,500, and assign it narrow moat and Medium Uncertainty ratings. Our fair value estimate implies a fiscal 2024 price/earnings of 30 times and enterprise value/EBITDA of 13.5 times, trading in line with the 10-year historical average and leading global peers. Rising uncertainty surrounding China and travel retail has triggered a sizable correction in its share price, sending shares to the bottom of the five-year trading range. While the daigou crackdown in Hainan and Chinese consumers’ boycott of Japanese brands might weigh on earnings through the first half of 2024, we deem the negatives to be temporary. Our projection of a more than 20% decline in operating profits in the second half of 2023 and the upside to our fair value estimate suggest the downside risk has been largely priced in. We reckon the dip creates opportunities to accumulate shares. Meanwhile, demand recovery of midprice cosmetics and the continued strength of prestige brands in Japan will serve as a key growth engine of near-term profits.

We consider the prestige cosmetics business in Japan exhibits moats underpinned by intangible assets and assign it a narrow moat rating. Specifically, Kose’s R&D capabilities in developing innovative and effective skincare products, coupled with consistent investment in marketing activities and beauty consultants, contribute to its brand equity. The entrenched retail relationship with specialty stores, the other key element of its intangible assets, plays a crucial part in its high market share of Japan’s prestige cosmetics market. While Kose’s sales are about two-thirds of Shiseido’s in Japan, the two core prestige brands, Decorte and Albion, generate sales 50% greater than Shiseido’s two largest prestige brands in Japan. We believe the meaningful sales scale of a single brand leads to high margins and returns which shore up marketing investment.