ANALYSIS - Niche cosmetics cos see no ugly risks from discounters

A model waits to apply make up at the Next Generation Fall/Winter 2010/11 Women's collection during Milan Fashion Week February 24, 2010.

BANGALORE (Reuters) - Retail giants like Wal-Mart Stores Inc(WMT.N) and Target Corp(TGT.N) are revamping and expanding their beauty aisles, but niche players like Ulta Salon(ULTA.O) or Sally Beauty(SBH.N) should hold their own as long as they continue offering small touches like customer service and free samples.

While women are still looking for discounts and bargains, personal care is as much about the 'feel good' experience as it is about products, and they are not ready to swap that entirely for the impersonal aisles of big-box retailers.

"These companies have built up a loyal customer base over the years as a result of the services they offer. For example, in many of these companies you have access to makeup professionals, which adds strong value to the purchase," analyst Brian Sozzi of Wall Street Strategies said.

Both Ulta Salon, Cosmetics & Fragrance Inc and Sally Beauty Holdings Inc have seen sales rise considerably in the last quarter, and have forecast a healthy second quarter ahead.

Shares of Sally Beauty has risen 11.1 percent so far this year, while those of Ulta have gained 25.9 percent. In contrast, the larger S&P 500 index has fallen 4.1 percent, according to Starmine data.

The cosmetics business somewhat straddles the divide between discretionary and essential spending. With consumers shopping a bit more since the recession, retailers are trying to lure shoppers into making that extra purchase of lipsticks or lotions -- high-margin products that boost their profits.

"In our economy, beauty and personal care is still an accessible luxury," said Bruce Cohen, a retail strategist at consulting firm, Kurt Salmon Associates.

Karen Grant, Vice President of beauty at market research firm NPD, said for a large number of customers, the overriding reason they buy at specialty retailers is that they can test a product.

THE WAL-MART (NON)SCARE

Though NPD's most recent sales tracking shows that there has been a rise in spending in U.S. department stores and the likes of Ulta, Sally Beauty and privately held Sephora for makeup and skincare, Grant said Wal-Mart's moves could be a factor for change.

"Across makeup and skincare categories, more than half of women who shop in higher-end department stores also shop in the mass market and drug stores for beauty products," she said.

(For a graphic on the U.S. cosmetics sales by retail outlet, click link.reuters.com/kad62m)

This makes the world's biggest retailer a possible rival to anyone selling the same products -- including store chains like Walgreen Co and CVS Caremark Corp, which often sell the same brands and have little customer-care to boast of.

For the big discounters that sell everything from lipsticks to licorice under the same roof, a better cosmetics aisle can also mean better overall sales.

"A trip for makeup could turn into a trip for the family's weekly groceries," Wall Street Strategies' Sozzi said. "Moreover, these products tend to turn quickly, thereby creating a source of stable cash flow," he added.

Wal-Mart, Target and Dollar General Corp have all revamped their cosmetics departments, cleaned up cluttered aisles and are stocking up on more upmarket names like Procter & Gamble's Olay Pro-X line, L'Oreal and Neutrogena as they try to keep up with stronger demand.

"Wal-Mart has brightened and put more space in their cosmetics section -- no more crouching in the aisle wary of the next cart that might hit you as you determine whether that Covergirl package had been opened before," said Martha Ciske, who shops for cosmetics at both Ulta and the discount chains.

Still, for Ciske and many others like her, it is really about their perception of value, and not just the price.

"One thing Target and Wal-Mart don't have that I know lures me to think about going to Ulta is their customer points, and their freebies," Ciske, a PR professional, added.

Also helping the specialty chains maintain their lead, is that the big box retailers cannot compete with them on their breadth of offerings.

So the mantra for the smaller chains should be to sustain those ranges, special discounts and the personalized attention to keep the customer coming back.

"Beauty is her indulgence, her bit of time (spent) on herself -- so not quite the same as picking up the laundry detergent and cereal," said Julia Beardwood, founder of Beardwood & Co, a branding firm that works with clients such as Limited Brands' Bath & Body Works.

"That's why she might prefer to separate the two experiences."

(Reporting by Nivedita Bhattacharjee in Bangalore; Editing by Anthony Kurian, Roshni Menon)