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Urbem's 'Megatrend' Series: Consumption Upgrade

One of the most powerful tailwinds benefiting consumer-facing businesses

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Jan 23, 2020
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The worldwide trend among consumers to buy premium is a phenomenal one. Euromonitor Research has been calling premiumization to be "the key megatrend through to 2030." People have an increasing demand for quality products and services that let them demonstrate success, live healthily, be active, feel unique, feel secure and even look younger. Augmenting that demand disproportionately is, of course, the rise of the middle class in many emerging markets.

We observe that some businesses have been excelling in capitalizing on capturing this megatrend of consumers trading up. A couple of them that we have followed are leveraging a brand-driven moat to generate high returns for their shareholders by taking advantage of this tailwind.

Take a look at Brown-Forman (BF.A) (BF.B) and Diageo (DEO) (LSE:DGE). These two companies together almost dominate the premium alcohol beverage industry, serving 180 markets globally through iconic brands such as Johnnie Walker, Jack Daniel’s and Guinness. Both businesses position themselves to support premiumization, as consumers want to drink better instead of more. No wonder both companies delivered a remarkable free cash return on capital over the last decade, as shown below. At the same time, the net income increased at a CAGR of 6.9% and 6.7% at Diageo and Brown-Forman, respectively.


Moving forward, we may expect a bit more emphasis on emerging markets in this space. For the next decade, Diageo's management anticipates an additional 730 million premium alcohol drinkers in total, with 85% of them coming from emerging markets, to add to the total market.

Other than drink better, consumers are also wanting to look better. Consider the growth story at French cosmetic giant L’Oréal (XPAR:OR) and its three significant growth engines – the luxury niche, the skincare segment and the dermo-cosmetic category. What is common among these three? They are all delivering double-digit sales growth (13.2% for L’Oréal Luxe, 18% for skincare and 13.6% for dermo-cosmetics, as of H1 2019). Over more than a century, the once-small hair dye manufacturer has transformed into the world’s largest cosmetic group, owning highly-ranked brands like Maybelline, Lancôme, Kiehl’s and Yves Saint Laurent in addition to its namesake one.

For the past decade, L’Oréal grew its earnings annually by 7.3% on average, which is quite decent, but not exceptional if compared to the 23.4% achieved by its major rival Estee Lauder (EL), the owner of Clinique, MAC and its namesake brand. To gauge the difference, we find that L’Oréal is more than two times bigger then Estee Lauder in terms of net income. Meanwhile, it is to our belief that the latter’s focus on prestige beauty is the most critical factor, resulting in higher average selling prices, more rapid market penetrations and better returns.

As you can see below, while both companies delivered consistently high returns on invested capital, Estee Lauder’s performance has been far superior.


Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the financial market. We do not own any security mentioned in the article.

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