An occupational hazard of writing across the sharemarket is having to cover unfamiliar pockets of market activity. Like women’s cosmetics and skincare products.
Clearly, it’s not my area of expertise (other than paying for these surprisingly expensive products from time to time). But rising demand for make-up and skincare is beautiful business for some ASX stocks.
Business forecaster IBISWorld estimates Australia’s cosmetics and toiletry retail industry will have sales of $3.9 billion in FY17. The industry grew modestly at 2.6 per cent annually over five years, thanks to stronger household spending on cosmetics.
IBISWorld predicts the industry’s annual growth will slow to 1.5 per cent over FY17 to FY22 because of heightened competition from supermarkets, discount department stores and a growing number of pure-play online cosmetics retailers. 
The sunscreen and other skincare product manufacturing sector in Australia has stronger prospects, argues IBISWorld. It estimates sector revenue of $290 million in FY17 and annual growth over five years of 6.7 per cent. Global players, such as L’Oreal, have traditionally dominated this market with skincare products, but local manufacturers are making headway.
These trends suggest the cosmetics and skincare industries have challenged outlooks as competition intensifies. But as so often happens, top-line forecasts, while useful, do not tell the full story for companies that are successfully attracting new markets.
Consider BWX, a developer, maker, distributor and marketer of branded skin and haircare products with an emphasis on the beauty and personal-care markets. Its key brands, owned or distributed, include Sukin, Derma, USpa, Edward Beale and Renew Skincare. 
BWX shares soared after it raised $39 million in an Initial Public Offering (IPO) on ASX in November 2015 at a $1.50 issue price. The shares spiked to $5.70 and now trade at $4.57, making BWX one of the best small-cap floats in years. 
Chart 1: BWXSource: The Bull
At its Annual General Meeting in October, BWX said it had “high confidence” in its FY17 underlying earnings (EBITDA) guidance of $26.2 million, which would be 30 per cent up on the FY16 result. BWX’s high growth rate has justified a rising valuation.
BWX impresses, but the recent drift in its share price suggests early enthusiasm is waning a little as the market digests a trailing Price Earnings (PE) multiple of almost 30 times (or 23 times on a forward basis using consensus forecasts). That’s demanding for a small cap with only a year of history as a listed company. 
Two of six brokers that cover BWX have a buy recommendation, three have a hold and one has a sell. A median share-price target of $5.34 suggests BWX is undervalued, although care should always be taken using consensus based on a low number of forecasts.
Those forecasts look too aggressive and falls this week, albeit in a weakening market, suggest investors are reappraising BWX’s price, and that better value will emerge in coming months. BWX is one for experienced investors to put on their watchlist in anticipation of better value. 
Micro-cap retailer McPherson’s looks more interesting on valuation grounds. 
The company sells hair and beauty products that include the Manicare, Lady Jayne, Revitanail and the popular Dr LeWinn’s brands. It also sells household consumables and appliances. 
The retailer has improving turnaround prospects. It rallied from a 64-cent low to $1.06, but remains well down on prices around $2.50 in mid-2013. 
Chart 2: McPherson’sSource: The Bull 
McPherson’s in August reported 12.3 per cent growth in after-tax net profit to $13.4 million for FY16. The health and beauty division delivered 47 per cent of revenue and the home-appliances division, under the Euromaid and Baumatic brands, delivered 24 per cent. 
The health and beauty division, the key to McPherson’s long-term prospects, continues to grow its share of overall revenue. The popular Dr LeWinn’s brand, which McPherson’s is advertising heavily, has good growth prospects. If its turnaround succeeds, McPherson’s could be a mini version of BWX – with a more attractive valuation. McPherson’s trailing PE of 5.5 times compares with almost 30 for BWX.
Granted, it’s not a like-for-like comparison:  BWX is a pure-play skincare company whereas health and beauty comprise just under half of McPherson’s revenue. Also, BWX has had much stronger growth, has an expanding global footprint and warrants a sharply higher valuation multiple. 
Also true is successful IPOs attracting plenty of market attention – and being bid too high – and low-profile microcaps with a history of patchy performance, such as McPherson’s, being overlooked or ignored.
McPherson’s has rationalised the business to three core segments, divested lower-margin businesses and is investing in its beauty brands. The strategy looks like the right makeover for McPherson’s and its recent operational performance is healthier.
McPherson’s suits experienced investors who understand the risks of investing in less liquid micro-cap stocks. 

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week’s newsletter

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. The article has been prepared without taking into account your objectives, financial situation or particular needs. Before acting on the information in this article you should consider the appropriateness and accuracy of the information, with regard to your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at November 3, 2016.