The Shilla Duty Free: Travel retail’s new beauty super force

SOUTH KOREA. In the space of just one month The Shilla Duty Free has emerged as an international travel retail and beauty powerhouse, following two contrasting but vital tender victories.

The Samsung-controlled company has been a much-respected force in its home market of South Korea for many years since it opened its first downtown store in Seoul in 1986.

For almost three decades it remained essentially a one-country operator, before its shock success in the Singapore Changi Airport perfumes & cosmetics tender of 2014, where it ousted long-term incumbent Nuance-Watson. That same year the retailer spread its wings further, taking advantage of Macau International Airport’s controversial decision to embrace a dual-retailer model and winning half of the spoils in a joint venture with Sky Connection of Hong Kong.

The Shilla Duty Free is the first retailer to have simultaneously secured duty free perfumes & cosmetics concessions across Incheon International, Hong Kong International and Singapore Changi airports

The Changi business, characterised by a troubled start-up and heavy (though easing) losses since, has proved a difficult international baptism for Shilla. But the product mix has improved sharply and its learning curve has been steep. The company openly admits that it bid knowing that it would lose money – but trusting that the operation would effectively act as a laboratory from which the lessons learned would help it flourish in future forays abroad.

Shilla travel retail locations

South Korea
Seoul downtown duty free
Jeju downtown duty free
Shilla IPark downtown duty free
Incheon International Airport
Thailand
Phuket downtown duty free
Singapore
Changi International Airport
Japan
Takashimaya, Tokyo
Hong Kong
Sweetmay
Macau
Macau International Airport
Sweetmay

The arrival of former Nuance Group President Roberto Graziani as a Board Member has added expertise, contacts and internationalism to Shilla’s deep-pocketed ambitions. But few thought Graziani, in his capacity as President of Shilla’s Travel Retail Division, could pull off the Hong Kong International Airport beauty & accessories concession in the face of the stiffest competition from regional and global heavyweights, including incumbent DFS Group, world giant Dufry and Shilla’s arch-rival Lotte Duty Free.

But succeed Shilla did, after a bid reliably understood to have impressed Airport Authority Hong Kong with its degree of innovation and focus on social and digital media, celebrity (Hallyu) marketing, and strong consumer engagement. When the company also snapped up the major Incheon International Airport Terminal 2 beauty concession just days later – meaning that by 2018 Shilla will control almost 71% of the perfumes & cosmetics footprint occupied by major retailers at Incheon – it completed a transformative month for the retailer.

The good news was a vital balance to months of troubled trading. After all, Shilla has been hit – along with all its rivals – by a dreadful slump in Chinese tourism and spending since the THAAD dispute with China erupted. And as our analysis of its first-quarter results in this special report shows, the combination of that dispute and a ludicrous proliferation of retail licences in South Korea (which has sent tour commission rates soaring) has had a terrible impact on operating profits.

Such turmoil in its home market makes Shilla’s recent international successes all the more important. Whether it can actually make money at Hong Kong International remains to be seen, but certainly the fact that Shilla is the first retailer to have simultaneously secured duty free perfumes & cosmetics concessions across the major hub airports of Incheon International, Hong Kong International and Singapore Changi is a game changer.

The jury remains out on the Phuket opening (characterised by spectacular high ceilings and high-impact fixtures) and its downtown duty free debut in Tokyo in late April, but these are important gains for a domestic force turned international player. And after all the troubles it has faced over the past year, few would begrudge Shilla some moments of celebration.

Beauty & accessories breakthrough: Shilla pledges to wow consumers and the industry with its HKIA executions
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From the grapes of wrath to a Super Tuscan

For Hotel Shilla Travel Retail President Roberto Graziani, victory in the Hong Kong International Airport (HKIA) perfumes & cosmetics tender must have been particularly sweet.

Shilla brand offer & space by key location

Seoul downtown duty free
370 brands • 7,178sq m
Jeju duty free
275 brands • 6,384sq m
Incheon Airport duty free
390 brands • 3,444sq m
Changi airport duty free
191 brands • 6,042sq m
Macau airport duty free
87 brands • 1,120sq m
Shilla IPark duty free
548 brands • 11,417sq m
Phuket duty free
432 brands • 8,155sq m

Not only had he helped the Korean retailer climb a further crucial rung on the international travel retail ladder, but five years earlier he had felt the bitter pangs of defeat when the incumbent (and hot favourite), Nuance-Watson, had lost both its HKIA concessions (beauty and airside general merchandise) to DFS Group (which, in a clean sweep, also picked up liquor & tobacco).

On that occasion Graziani did not hold back on his views, opining very publicly that the victor had bid way beyond what the concession was worth. History would prove him right – although this was largely down to an extraordinary change of circumstances with regard to Chinese luxury consumption, following Xi Jinping’s sweeping crackdown on corruption and excessive spending following the 18th National Congress of the Communist Party in 2012.

Commenting on the HKIA success, Graziani said: “This highly competitive win is attributed to our teams’ innovative category insights and our deep understanding of customer needs, as well as our long-standing operational excellence.

“We are grateful to the Airport Authority for this vote of confidence and look forward to offering to our customers – and all stakeholders – offers, services, and operational performances which will stay abreast of trends and changes in consumers’ preferences, always maintaining a strong competitive edge throughout the length of the concession.”

Five years, then, is a long time in travel retail. For the veteran Italian retailer and wine aficionado, those grapes that must have tasted so sour last time around would on this occasion have exuded all the allure, power and sheer joy of the great Super Tuscan, Sassicaia.

Street talk: Hotel Shilla Q1 results – analyst reaction

Leading analyst Mirae Asset Daewoo maintained its ‘Buy’ rating on Hotel Shilla and raised its target price by +21% to KRW75,000 in the wake of The Shilla Duty Free parent company’s first quarter 2017 results.

Hotel Shilla reported a +14.9% rise in consolidated revenue to KRW1.02 trillion (US$903.7 million) for the quarter. However, group operating profit slumped by  48.2% to KRW10 billion (US$8.86 million) as a result of a whopping -39% slump in Korean duty free profits, caused by soaring tour group commission rates (brought on by the proliferation of duty free licences) and high promotional costs.

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Click on image to enlarge

Revenue, which topped KRW1 trillion for the first time, beat the market consensus estimate by +9.5%, according to Mirae Asset Daewoo.

Despite stiffening competition and the collapse in Chinese tourism from the middle of March due to the THAAD dispute with China, Shilla’s Korean downtown duty free revenue grew steeply (+23.7% year-on-year) to KRW603 billion (US$534.3 million). However, Korean airport duty free sales fell by -1.6% year-on-year to KRW185 billion (US$163.9 million). The company’s Korean market duty free sales overall rose by +17% to KRW787.6 billion (US$695.8 million).

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Click on image to enlarge

The next quarter, however, is certain to prove much more testing amid a drastic fall in Chinese visitors due to the THAAD controversy.

Assessing the results, Mirae Asset Daewoo Research Center Equity Analyst (Cosmetics, Hotel & Leisure, Fashion) Regina Hahm noted Shilla’s recent double success in winning the perfumes & cosmetics concessions at Incheon International Airport Terminal 2 and Hong Kong International Airport.

“Of the country’s two major airlines, the top carrier [Korean Air] is highly likely to operate out of T2,” she noted. “From 2018 Hotel Shilla will control 70.8% (in terms of total area) of all cosmetics/perfume duty free shops operated by general enterprises at Incheon International Airport.

“And given T2’s advantageous location, the company’s market share in terms of revenue should exceed its share in terms of total area.”

Hahm also highlighted what she described as “an entirely new chapter in the history of local retailers”, with Shilla being the first retailer to have simultaneously secured duty free perfumes & cosmetics concessions across Incheon International, Hong Kong International and Singapore Changi airports.

“Given the sharp improvement in the company’s fundamentals and competitiveness, short-term earnings results are now of less importance for investors,” Hahm continued.

“We thus change our valuation period to 2018F to better reflect forecasts for earnings stabilisation and the growing value of duty free operations with expansions to Incheon T2 and Hong Kong International Airport.

“Now having secured duty free concessions for perfume & cosmetics in those three major hub airports, Hotel Shilla will likely benefit from medium/long-term improvement in negotiating power and cost efficiency.”

Singapore springboard: Shilla’s entry to Changi Airport was the first in a series of big overseas successes
The recent Phuket off-airport opening gives Shilla a vital foothold in the fast-growing Thai tourism market
Shilla has cemented its status at Incheon International Airport with the capture of the major Terminal 2 P&C concession (T1 store pictured)
Shilla excels with its high-profile social media presence and its outstanding celebrity marketing

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