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Why Did Beauty Companies’ Operating Margins Shrink in 4Q15?

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Pressure on margins

Beauty companies have been investing heavily in growth initiatives such as store expansions, new product launches, brand enhancements, and media formats, which is impacting their margins.

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Profitability comparisons

Procter & Gamble’s (PG) gross margin increased 170 basis points to ~50% in 4Q15. On a currency-neutral basis, the company’s core gross margin increased 290 basis points, driven by 100 basis points from lower commodity costs and a 130-basis-point benefit from pricing. Also, its operating margin increased to 22.8% due to productivity savings.

Coty’s (COTY) 4Q15 gross margin also reported a slight improvement. Its adjusted gross margin increased 130 basis points to 61.5%, driven by supply chain efficiencies and a lower level of promotional and discounted pricing activity. Although Coty’s operating margin fell to 12.6%, its adjusted operating margin grew 180 basis points to 17.7% from 15.9%.

At 81.2%, Estée Lauder’s (EL) gross margin fell flat with the margin of the same quarter of the previous year. The positive contributions of the supply chain were offset by the category mix, with slower growth in skincare and some higher promotional expenses over the holidays. While the company’s operating margin fell to 20.1% in 4Q15, its constant currency operating margin improved by 60 basis points, primarily due to expense leverage.

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Avon’s (AVP) adjusted gross margin fell by 270 basis points to 58.8%. This was due to the Brazilian VAT (value-added tax) credits in 2014 and IPI (industrialized products tax) in 2015, which negatively impacted the gross margin by ~70 basis points. The adjusted operating margin fell by 420 basis points to 6% in 4Q15. The decrease was primarily driven by foreign currency translation and transaction costs.

Protecting margins

With changing consumer behavior and rising disposable incomes, there has been an increased demand for beauty and personal care products. Like peers L’Oréal (LRLCY) and Shiseido (SSDOY), Coty and Estée Lauder also aim to strengthen their product categories by increasing pricing across geographies to protect margins.

PG makes 6.3% of the iShares Core High Dividend ETF (HDV) and 2.6% of the iShares S&P 500 Value ETF (IVE).[1. As of March 21, 2016]

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