In his first lesson on potions making, Professor Snape (fictional character from the Harry Potter series) proclaimed that “I can teach you how to bottle frame, brew glory….”.

But he could also be talking about perfumes or foundations, from the premium prices that people are paying these days for the top brands in hopes of obtaining real or imagined benefits.

The global cosmetics industry is one that displays remarkable resilience even in trying times and can give an impressive performance in a developing economy like China, where the industry is flourishing, boosted by changing lifestyles and rising disposable income. Recently, the Chinese economy continued to race ahead despite the sub-prime crisis with an impressive 10.6% growth in 1Q08.

Following a renewal of interest in S-shares, it might be valuable to look at Beauty China (BC), which has been unfairly beaten down to a mere 10.8x FY07 earnings.

While facing higher cost of plastics packaging material and slower-than-expected ramp up of production at its newly acquired cosmetic factory, BC has been giving a good account of itself.

SHIFT IN STRATEGY
BC is engaged in the business of brand management of cosmeties and skincare products.

Essentially, focusing on the creation and development of new products and promoting them to customers and distributors while outsourcing non-essential business functions such as production, administrative functions relating to logistics and purchasing, allows the company to concentrate on its core competencies.

Currently, BC markets two lines of cosmetics - the Colour Zone brand (BC’s main revenue generator and flagship brand), targets young urbane women in China while the CharmingLady series targets women who are above 25 years old with higher disposable income.

Nonetheless, the company broke with its tradition of outsourcing following the acquisition of Fu Teng International, which indirectly owns a new GMP-compliant factory in Guangdong.

The acquisition was conceived for a number of reasons. As the Chinese government tightens supervision over cosmetic production, gaining control over its own manufacturing facilities ensures that the quality of its product meets increasingly stringent regulations.

Moreover, acquiring of one of the few GMP-compliant factories in the Middle Kingdom, opens up another revenue stream for the company. BC is now capable of tapping into the OEM business by producing for foreign brands. In December 2007, the company won HK$7m worth of contracts from 5 new foreign customers. In addition, the company also received a letter of intent from a customer in France to manufacture 12m bottles of perfume by 2009.

SOLID EARNINGS
FY07, BC announced a record turnover of HK$632m or a 35.6% surge year-on-year. The increase in turnover was brought down to the bottom line, which swelled 20.1%. Overall, BC had continued to deliver increases in earnings and revenue since FY03. On a CAGR basis, turnover and profit soared 35.4% and 25.1% from FY03 to FY07.

The only thing worrying though is the decline in both gross and net profit margins from FY03, reflecting BCʼs inability or reluctance to pass on costs to the consumers. Margins could continue to stay depressed as the firm proceeds to expand its distribution networks and ramp up production. Nonetheless, obtaining a firm foothold in China is vital for BC to become an important player in the expanding cosmetic industry.