The dilemma of the top perfume stock in China

When perfume becomes a social calling card, a sensory economy that replaces the lipstick economy is accelerating. The Chinese perfume market is a highly attractive growth opportunity, with a projected compound annual growth rate of 13.4% from 2023 to 2027.

Based on 2023 retail sales, YingTong is the largest perfume brand management company in mainland China, Hong Kong, and Macau, and the only Chinese company listed. On July 18, the company officially submitted its prospectus to the Hong Kong Stock Exchange for a planned listing on the main board.

However, just as YingTong, poised to become the first listed perfume company in China, faces the trend of young people using perfume for social interactions and the development of the Chinese perfume industry, it has a dilemma - the brand it represents is not its own. Because when people start to "smell and know people," the brand is the confidence and the most important asset in this social behavior and industry.

I. The Most Hardcore Customers

Based on 2023 retail sales, YingTong is the largest perfume brand management company in the Chinese market, including Hong Kong and Macau. The brands it represents are very hardcore luxury brands such as Hermès, VERSACE, Van Cleef & Arpels, Chopard, Albion, and others.

In terms of product categories, the company's revenue gradually increased from 1.675 billion yuan to 1.864 billion yuan from the 2022 to 2024 fiscal years, with perfume distribution revenue being the core source of revenue, increasing from 1.495 billion yuan to 1.524 billion yuan, accounting for over 80%.

Different from being the brand owner, YingTong is the only brand agency company in the industry's CR5, able to stand at the forefront of the industry with a special status, because YingTong has a significant competitive advantage in the perfume sales industry by mastering a large offline distribution channel.

As consumers need to smell and experience perfume to understand its characteristics, physical stores have been the preferred channel for end customers for a long time. YingTong's layout of over 7,500 offline outlets in more than 400 cities in China (including Hong Kong and Macau) provides international brands with the convenience of light-asset operations to enter the Chinese market. It not only solves the brand's entry strategy and distribution network planning in new markets but also provides advice on consumer catering strategies.

This comprehensive brand management capability enables YingTong to establish and maintain strong relationships with brand licensors, with typical cooperation periods lasting over 10 years In the past three years, the "olfactory economy" has been experiencing vigorous development in the Chinese market. According to Euromonitor International's forecast, by 2025, the retail sales of perfumes in China will reach 30 billion RMB, three times the global market growth rate. This trend has also given Yingtong the confidence to impact the secondary market, as the continuous advancement of domestic consumers leading to rapid growth in perfume demand has motivated Yingtong's hardcore clients to enter the Chinese perfume market.

InterParfums is a globally renowned high-end perfume developer and Yingtong's second largest supplier. InterParfums' leading brands in the Chinese market include Coach, Montblanc, Jimmy Choo, and Van Cleef & Arpels. In the future, the company is also preparing to launch its own perfume series mainly for distribution in Asia. In the first half of this year, sales in the perfume and cosmetics department of Hermes continued to grow by 4.9%. In order to boost sales, Hermes has also held multiple perfume flash sales events in cities such as Shanghai, Beijing, and Chengdu.

As a full-channel management group for these brands, Yingtong should benefit from the increased market investment by its client agents. However, the degree of benefit is relatively smaller compared to the brands themselves, as the profit margin for acting as an agent is much lower. In front of hardcore clients, Yingtong takes on the dirtiest and most tiring tasks, and what's even more challenging is that, despite their hard work, the company still faces the risk of clients not renewing contracts.

II. Disruptive Business Model

Just as real estate agents fear landlords renting out directly, Yingtong fears brands transitioning to direct operations.

The business model of brand agency determines that downstream sales of Yingtong are constrained by distributors, while upstream supplies are constrained by brand owners. From the perspective of downstream sales channels, the company's share of self-operated external sales is less than 1/4, still heavily relying on third-party channels.

The key difference in Yingtong's agency business model lies in the fact that most of the sales channels are non-self-operated, and while helping to promote other brands, they bear the heaviest channel costs. Therefore, despite maintaining a gross profit margin of over 50% in the past three years, Yingtong's net profit margin is only around 11% due to the need for significant marketing expenses, similar to traditional traders.

From the supply side, the company's suppliers are concentrated and heavily reliant on a single major client.

The higher the dependence on hardcore customers, the greater the risk they face. For YingTong, the risk of luxury brand agency transitioning to self-operation is currently the biggest concern. But why is there a risk for customers to transition from agency to self-operation? Because the current domestic consumption market in China is really difficult to navigate.

L'Oréal is the world's largest beauty group, and its financial report can basically provide an overview of the global beauty market. In the first half of this year, L'Oréal's luxury goods department grew by 2.3% year-on-year. In terms of regions, Europe, North America, and emerging markets performed strongly, with only Mainland China showing poor performance, where only the perfume business driven by brands such as Yves Saint Laurent, Valentino, Maison Margiela, and Prada rebounded.

As one of the few growing categories for L'Oréal in China, perfumes are likely to become the target for major luxury goods groups to transition from agency to self-operation in the Chinese market. For example, Kaiyun Group announced the establishment of a beauty department last year, and LVMH, the parent company of Van Cleef & Arpels, also established a high-end perfume and beauty business department, which could potentially reclaim the sales agency rights of Van Cleef & Arpels at any time.

Furthermore, although creating an offline place suitable for experiencing fragrances is crucial for perfume brands, the distribution market in China is too unique, and the dominant position of offline sales is gradually being broken. For example, in 2022, Interparfums generated 73% of its sales in China through online channels, while sales from offline brand boutiques accounted for only 4%.

The unique characteristics of the distribution channels in China have made the sales channels of the perfume economy, which originally heavily relied on offline experiences, more diversified. For brand owners, the economic impact of directly expanding online is becoming increasingly significant.

Firstly, under the de-centralization of traffic on major platforms, the "equality of all beings" in platform traffic, and the online operational effects are easier to quantify through algorithms and traffic data, making brand management more centralized and efficient. Secondly, brands themselves naturally have a large number of brand believers with a natural flow effect, and the online network effect and algorithm recommendations lead to much more efficient user conversion than offline distribution.

The evolution of this distribution channel means that YingTong's offline sales network advantage is gradually being eroded, and for the company, the risk of losing important suppliers is increasing. This risk became a reality not long ago. In December 2022, after the agreement between YingTong and a major brand licensing partner expired, the brand decided to operate independently and not renew the contract. The revenue brought by distributing this brand for YingTong Holdings in that period amounted to as much as 425 million RMB, accounting for 25.5% of the total revenue for that year.

Although this termination did not directly lead to a decline in YingTong's full-year performance, 2023 is a big year for the opening up after the pandemic, tourism recovery, and the increase in passenger flow at international airports and duty-free shops. Without this termination, the company should have achieved higher growth.

In the face of this potentially exacerbating gray rhino, the company is also strengthening its response. Since 2022, relying on its channel advantages, YingTong has established and operated its own perfume brand, and the company is not limited to just perfumes but has chosen to diversify into cosmetics, skincare, and eyewear agencies to promote comprehensive business development Of course, as mentioned in the above analysis, the agency business model is ultimately not sustainable, so this IPO push aims to develop its own brand as the top fundraising purpose for the company.

III. Building a brand is very challenging

In an immature market, early development is often dominated by mature foreign brands.

By 2025, China's perfume retail sales will reach 30 billion yuan, three times the global market growth rate. In this 30 billion market, the market share of mass-market perfumes is expected to decrease by around 15%, while niche perfumes and the high-end market they represent will grow by 18%. With the increasing demand for niche perfumes in China, the track capacity will expand, accommodating more brands. This industry trend has provided a fertile ground for YingTong's self-owned brand.

In 2022, the company chose to produce its own Santa Monica brand products through OEM, launching 5 entry-level high-end perfumes to the market. Additionally, the company began to reshape its self-operated offline channels. From the 2022 fiscal year to the 2024 fiscal year, the number of traditional offline stores/counters decreased from 102 to 87, gradually increasing its presence on e-commerce platforms.

A series of measures have driven the revenue of self-owned brands from 1 million yuan in 2022 to 17 million yuan in 2024, a significant increase. However, the proportion of self-owned brands in annual revenue is only 0.9%, with external brand agency sales still being YingTong's main source of income.

Although industry trends provide a fertile ground for nurturing new brands, in an immature market, early development is often dominated by mature foreign brands. Consumers' recognition of products often tends to be biased towards "worshipping foreign things" first, as is the case with cars, phones, and especially beauty and personal care products.

Related data shows that in 2020 and 2021, the sales of niche perfumes on Tmall International saw double-digit growth year-on-year, far exceeding the overall growth rate of the perfume category. Brands like Maison Margiela and Tom Ford entered the TOP10 list. By 2023, these niche perfumes continued to rank high in sales.

However, upon closer observation, it can be seen that these niche perfumes are not truly niche. Although those listed are not as well-known as commercial fragrances like Chanel No. 5 or Dior Sauvage, each brand has its own reputation. The term "niche" here is used to distinguish fragrance types, not to indicate that the brands themselves are newcomers or truly niche.

Between 2018 and 2021, nearly 300 new local perfume companies joined the market each year. However, with international brands increasing their presence in live streaming e-commerce and expanding their reach, the market share of overseas commercial perfumes and niche perfumes has significantly grown. Under this double pressure, the performance of new domestic perfume brands has been lackluster, with a slight decrease in market share compared to 2022.

Of course, despite Chinese brands being in a weak position in the fierce industry competition, it does not mean that self-owned brands have no development opportunities. For example, the oriental fragrance brand GuanXia, with its unique charm, became the first domestic high-end brand to enter the top 30 in sales from January to May this year.

However, a very important premise is that GuanXia has received investment support from L'Oréal. The key to the success of domestic brands is to have the financial resources to invest heavily in marketing.

In the fiscal years 2022 to 2024, YingTong Holdings achieved net profits of 171 million yuan, 173 million yuan, and 206 million yuan respectively, totaling 550 million yuan. However, it is worth noting that before going public, YingTong had already distributed all the money earned to shareholders, with a total dividend of 631 million yuan. Liu Jurong and his wife Chen Huizhen indirectly hold 90% and 10% of the shares of YingTong Holdings, respectively. Over the three years, this couple received a total of 631 million yuan in dividends, which is 81 million yuan higher than the company's three-year net profit.

High dividend payouts will obviously affect the company's reinvestment capability. As of May this year, the company's cash and cash equivalents amount to 188 million yuan. Despite having no interest-bearing debt, this amount of cash is clearly insufficient to support YingTong in facing competition from peers under the high-investment marketing strategies of international big brands.

As a veteran who has been working in the industry for decades, Liu Jurong cannot be unaware of the significant initial investment required for new brands. In this situation, a complete divestment-style dividend payout seems a bit unethical.

IV. Conclusion

As perfume becomes a new social currency, and as almost all luxury conglomerates face deflation in China, brand agents' positions will gradually be squeezed by brand owners.

China is a rapidly growing market in the perfume industry, but it is also a market with huge upfront costs for market education and brand building. Compared to Europeans' strong physiological need for fragrance and the romantic genes that have existed for hundreds of years, which almost naturally drive their demand for perfume, many Chinese people, especially in the Guangdong and Guangxi regions, still use Six-God floral water more frequently than perfume in the hot summer. Cultivating a niche brand without a solid foundation in a fiercely competitive and immature market is extremely challenging.

However, YingTong still maintains a good competitive advantage in channels, and the value of this advantage can still be leveraged in the sales of its own brands. In addition, the company's proficiency in domestic market marketing also makes it possible for the company to be sought after by unfamiliar international enterprises looking to cooperate or acquire in the Chinese market ​