Household Goods:Overseas marketing feedback:Pessimism dominates

Valuations look demanding after steep gains ahead of 3Q earnings season:The KRX cosmetics index has risen more than 40% since mid-September to trade at over26x forward P/E (close to the global peer average) after having dipped below 22x (a20% discount to global peers). Most of the overseas investors we met doubt whetherKorean cosmetics stocks deserve their current valuations—which are at pre-2016 highs—given that sector earnings growth seems unlikely to recover to pre-2016 levels. They wishto see earnings improvements before making further investment decisions. In our view,investors need to focus on earnings momentum over valuations, as upward revisions toearnings estimates are looking increasingly likely.

    Debate over Korean cosmetics products’ competitiveness: The overseasinvestors we met on a recent marketing trip find Korean cosmetics stocks demandingmainly because they are pessimistic about a recovery in Chinese demand for Koreanproducts specifically. They have questions about whether Korea is still an attractivedestination for Chinese travelers (pointing to Korea’s geopolitical risk), and whetherKorean brands will be able to outperform global brands given that Chinese demand forglobal brands (particularly Japanese ones) has been surging since early 2017. We agreethat the shift in Chinese consumption patterns (ie, from skincare to makeup products)and consumers becoming less sensitive to price are negative for Korean cosmetics.

    However, we believe overseas investors’ concerns are overblown. Korea’s cosmeticsexports to non-China regions (including the US, Europe, and Southeast Asia) grew morethan 30% y-y in 2017, which speaks to the competitiveness of such products. Meanwhile,we believe a shift in global consumption from western to Asian brands (including Koreanand Japanese ones)—which has been underway for several years—carries moresignificance than the swing in Chinese consumption toward Japanese brands (which weattribute to anti-Korean sentiment). The increasing presence of Japanese brands inChina’s cosmetics imports is partially due to a decline in the Korean portion of importsand partially due to a decline in the French portion.

    Meanwhile, Korea’s cosmetics exports actually grew 34% y-y in November, adding togrowth momentum that has been building month by month after hitting bottom in April.

    Indeed, we believe export strength in November was driven by China, which testifies tothe validity of our forecast of a fast recovery in Chinese demand.