Sector Overview

Sector Over view

Cosmetics Industr y

According to Cosmetics Europe, in 2020, the region’s retail market for cosmetics and personal care was worth EUR 76.7bn. Collectively, Europe’s market is the largest in the world, with Germany (EUR 14.0bn), France (EUR 11.5bn), the UK (EUR 9.8bn), and Italy (EUR 9.7bn) holding the largest market shares, followed by Spain (EUR 6.4bn) and Poland (EUR 3.8bn).

It is estimated that the cosmetics and personal care industry brings at least EUR 29bn in added value to the European economy annually. About EUR 11bn is contributed directly by the manufacturers of cosmetic products and EUR 18bn indirectly through the supply chain. Including direct, indirect, and induced economic activity, the industry supports over 2 million jobs. In 2020, over 229,400 people were employed directly, and a further 1.69 million indirectly in the cosmetics value chain. The vast majority of Europe’s 500 million consumers use cosmetics and personal care products every day to protect their health, enhance their well-being, and boost their self-esteem. Ranging from antiperspirants, fragrances, makeup, and shampoos, to soaps, sunscreens, and toothpastes, cosmetics play an essential role in all stages of our life and have important functional and emotional benefits.

Within the European industry, skincare forms the largest segment, generating about EUR 21.45bn in retail sales in 2020, followed by toiletries (EUR 21.24bn) and hair care products (EUR 14.14bn). Other larger market segments include fragrances/perfumes (EUR 10.49bn) and decorative cosmetics (EUR 9.39bn). Exports of cosmetic products from Europe totalled EUR 22.6bn in terms of trade value during 2020. France and Germany were Europe’s main exporters, together accounting for over 50% of the total global exports from Europe. In terms of intangible asset values, the industry is also vital for Europe, with the region’s leading brands valued at more than EUR 45bn – 26 out of the top 50 global cosmetics brands are European. The cosmetics and personal care industry is a science-driven and highly innovative sector that makes large investments in R&D. In Europe, most of the large-scale companies in the industry spend about 5% of their annual sales on R&D. In 2018, there were at least 77 scientific innovation facilities in Europe that carried out research for cosmetics and personal care industry. Large industry players have multiple research centres that focus on product development, market research, and regulatory compliance. An increasingly visible trend across Europe is towards greater sustainability, with a growing commitment from industry to enable consumers to benefit from products meeting these standards. MADARA is fully committed to the sustainability principle, operating specifically in the segment of natural and organic cosmetics and personal care. Organic personal care and cosmetics products are made from plant extracts and natural ingredients that contain minimal or low amounts of synthetic ingredients formulated or manufactured by a chemical process and have chemically altered a substance derived from a naturally occurring plant, mineral, or animal source. These products are widely considered safer and more beneficial than regular personal care and cosmetic products. Government organisations in various countries are encouraging the use of organic ingredients over synthetic ones in cosmetic products, thereby supplementing the market growth. The recent tendency to question the side effects of many substances used in conventional cosmetics, combined with an increasing appreciation of the merits surrounding environmental sustainability, has encouraged many consumers to turn to ‘green’ cosmetics. Such cosmetics products are normally certified by ECOCERT under different certification classes depending on product specifications. Consumers increasingly prefer products labelled as ‘natural’ or ‘organic’ to conventional products. Consumer and retail analysts emphasise that there are three main factors contributing to the growth of the global organic personal care market. These include demand for (a) chemical-free, (b) multifunctional organic products, and (c) new formulations. So where is this demand coming from? Socially conscious consumers are the new driving force behind market trends. Buying ethical goods is now cooler than it has ever been before, particularly as environmental awareness is becoming mainstream in the millennial and Generation Z markets. Social media is key to the shift in consumer demand. Trends are shared more quickly and emotively, with celebrities and influencers — as well as everyday people — posting content that urges everyone to become a conscious consumer. However, it would be a disservice to the intelligence of consumers to claim that the move towards natural products is only due to celebrity influence or peer pressures. Instead, it seems that as the world changes, a new form of consumerism is emerging, based on principles of awareness and caring about people and the planet. Consumers want their purchases to be good for their bodies and good for the world. Natural cosmetics are usually priced higher than their synthetic counterparts. This is because the cost of natural ingredients changes year on year and is directly affected by uncontrollable environmental factors, and the manufacturing process for organic and natural products is more labour-intensive. However, the bigger price tag is not dampening demand. In the haircare market, for example, products containing coconut, marula, argan, and almond oils are gaining traction over products containing harsh chemicals, which are now known to damage hair. In short, increasing interest in beauty and personal care, coupled with growing health awareness, are the key factors propelling the growth of the organic personal care and cosmetic products market. Overall, these factors have fuelled the industry’s strong growth over the last decade and are likely to continue to do so, making natural and organic cosmetics the most dynamic segment of the global personal care market. According to the information available on www. reportlinker.com, the global natural and organic personal care market is estimated at USD 12.7bn in 2020 and is projected to reach USD 23.6bn by 2027. Skincare is projected to record a 10.9% CAGR and reach USD 9.4bn by 2027, while the haircare segment is forecasted to grow at an 8.3% CAGR for the next seven years. In 2020, the US market was estimated at USD 3.4bn, while China is projected to grow at a 16% CAGR to reach USD 6.4bn by 2027. Japan and Canada are projected to grow at a CAGR of 3.4% and 7.6%, respectively, over the 2020-2027 period. Germany is the second-largest market in the world and the largest in Europe, with EUR 1.3bn turnover, forecasted to grow at a CAGR of 5.2% during 2020-27, followed by France (EUR 0.8bn). According to another market research provider, Allied Market Research, the global organic personal care and cosmetic products

European Cosmetics and Personal Care Market (EUR bn)

21.5

3.8 6.4

9.7 14.0

11.5

9.8 Germany France

UK

Italy Spain Poland

Others

Source: Cosmetics Europe

market is expected to garner USD19.8bn by 2022. According to Ecovia Intelligence, the natural and organic cosmetics market in Europe grew c.a. 7% per year from 2013 to 2018, well ahead of the overall cosmetics market. In 2018, the total European market of natural and organic cosmetics reached c.a. EUR 3.8bn, up 7.2% y-o-y. The market volume is expected to reach at least EUR 5bn by 2023, growing at a CAGR of 6.3%. A general consensus among different market research providers is that Asia-Pacific would be the fastest-growing market in the next few years. In terms of sales channels, in Europe, speciality stores dominate the natural and organic cosmetics market. Although their importance is decreasing, they still accounted for 38% of sales in 2018, ahead of pharmacies and drugstores (33%). General retailers accounted for 7% of sales of natural and organic cosmetic products, while other retail channels (perfumery shops, hairdressing salons, beauty salons, online sales, etc.) accounted for 23% of total sales. Increasing rates of internet penetration worldwide, together with ease of availability and attractive discounts coupled with the COVID-19 pandemic impact which created obstacles to the conventional sales channels, has led to a growing preference of consumers to buy online. According to Loreal annual cosmetics research 2020, around 22% of total sales were made through e-commerce channels compared to 14% in 2019. For many companies, online sales has become the channel of choice, allowing them to increase market penetration, consumer reach, and expand their consumer base. Therefore, while demand for organic cosmetics is growing, the customer’s interaction and experience, using diagnostic tools and digital apps, as well as electronic payments and delivery, are also transforming the industry. For e-commerce sales, retailers must continue to invest in omnichannel presence, bundling together retail, online, and mobile app stores with other methods of engaging with a customer. Several communication channels give the customer the ability to remain in constant contact with a retailer through multiple means. The return on investment generated by more positive customer experiences can be quantified by correlating it with customer loyalty. Apart from changing consumer preferences, the legislative landscape in Europe is also a growth driver for natural and organic personal care products. The European Green Deal (‘EGD’) is the European Commission’s new growth strategy to transform the EU into a sustainable and prosperous society with a modern, resourceefficient, and competitive economy. This ambitious strategy and its policy initiatives aim for net-zero greenhouse gas emissions by 2050 and seek to decouple economic growth from resource use. The EGD will drive the EU’s policy and regulatory frameworks for many years to come and will deeply affect the external operating environment for the cosmetics sector which will be obligated to face a series of policies, over 30 strategies, and a great number of initiatives. The first thing the cosmetics companies will have to tackle will be the challenges related to introducing sustainable packaging. However, many activities are already voluntarily applied by companies on their own initiative, including MADARA which applies reusable and BPAfree packaging. Businesses that were thinking forward have already implemented (and most importantly tested) the systems and innovative solutions in the field of eco-design of packaging, recycling, contact with the consumer, and environmental marketing declarations. Now, they will only need to adjust to the new regulations which shorten the transition time.

A further step in the transformation seems to be a revision of the rules for product safety assessment. Probably, all cosmetic regulations will be based on risk assessment. The Commission intends to carefully assess the environmental footprint and risk to human health of each substance contained in the products. An ingredient considered hazardous to health or the environment will be allowed to be used only in the categories of products considered essential. However, the criteria for indicating the essential products have not been published yet. On 25th April 2022, the European Commission published a “Restrictions Roadmap” as part of the EU’s Chemicals Strategy. The roadmap sets out priorities for the European Chemicals Agency before the revision of the REACH Regulation (estimated for 2027). The plan focuses on entire classes of chemical substances for the first time as a rule, including all flame retardants, bisphenols, PVC plastics, toxic chemicals in single-use nappies and PFAS, which are also known as “forever chemicals” because of the time they take to naturally degrade. A new study by Notre Dame University concluded that many cosmetics sold in the United States and Canada likely contain high levels of PFAS, a potentially toxic class of chemicals linked to a number of serious health conditions. Scientists tested more than 200 cosmetics including concealers, foundations, eye and eyebrow products and various lip products. According to the study, 56% of foundations and eye products, 48% of lip products, and 47% of mascaras tested were found to contain high levels of fluorine, which is an indicator of PFAS use in the product. For MADARA, since all products and production facilities have been ECOCERT certified since 2008, which means that the raw materials allowed to use are those that do not adversely affect the environment and people, PFAS is not part of the product formula and there is a good reason to believe that there will be nothing or nothing significant in the new roadmap to pose a risk or change to the Company’s existing products. In 2020, the European Commission launched the New Consumer Agenda to empower European consumers to play an active role in the green and digital transitions. The New Consumer Agenda aims to present a vision for coherent EU consumer policy up to 2025 and to consolidate the EU consumer protection law. The Commission aims to ensure that sustainable products are available to consumers in the EU market and that consumers have better information to be able to make an informed choice. The Commission will present proposals to equip consumers with better information on the sustainability of products and to fight practices, such as greenwashing or early obsolescence. The Commission will also promote repair and encourage more sustainable and “circular” products. One already taken initiative was implemented in October 2021. The European Commission adopted new EU Ecolabel criteria for cosmetics and animal-care products, offering consumers across the EU the benefit of trusted proof for genuine green brands. Currently, three out of four care products sold in Europe display an environmental claim or label, and yet many of these claims are difficult to understand or confusing for the consumer. The EU Ecolabel is a reliable third-party verified label of environmental excellence, which takes into account the environmental impact of a product throughout its entire life-cycle, from the extraction of raw materials to the final disposal. The updated EU Ecolabel criteria will now apply to all cosmetic products, as defined under the EU Cosmetic Regulation. The previous requirements for cosmetics to be awarded the EU Ecolabel covered a limited range of so-called ‘rinse-off’ products such as body wash, shampoo, and conditioner. The updated rules include ‘leaveon’ cosmetics such as creams, oils, skin care lotions, deodorants and antiperspirants, sunscreens, as well as hairstyling and make-up products. Although MADARA does not possess the Ecolabel, the ECOCERT is widely recognized with its rigid standards for natural and organic cosmetics and ecological packaging, thus acquiring Ecolabel would be a great addition to the brand, but, currently, it already possesses the qualities demanded and recognised by consumers. Eventually, consumers are becoming more aware of the

sustainability claims and do pay increasing attention to labels which can be trusted.

Guided by consumer preferences and growing concern for chemicals in cosmetic products, more and more new natural and organic brands are entering the natural and organic cosmetics or personal care market, including the well-known personal care giants like L´Oreal or Jonson & Jonson. Current strategies employed by large players are new product launches and acquisitions or partnerships with local players. For example, Forest Essential, in December 2020, released an organic makeup line while Garnier launched “Garnier Bio” organic skincare line in cooperation with NGO foundation, GoodPlanet, in 2019. In the past years, it has been proven that product association with well-known figures in society, generally referred to as “influencers”, does create a substantial boost in product performance. One of the reasons behind that is the increasing penetration of technology and social media, which enables the content to reach billions of people in seconds and is distributed further by viewers. This approach is widely used in the personal care industry. The original influencers, famous actors and musicians have lent their faces (and hair and bodies) to countless ad campaigns for beauty brands, and to this day, they still do, often as extremely well-compensated brand ambassadors. But it seems, nowadays, being a beauty-brand spokesperson simply isn’t enough for some of the more aesthetically eager and ambitious celebrities. We are living in the age of the celebrity beauty brand. Out of many examples some are Rihanna: Fenty Beauty & Fenty Skin, Jennifer Lopez: Jlo Beauty, Alicia Keys: Keys Soulcare, Selena Gomez: Rare Beauty, Kim Kardashian: KKW Beauty & KKW Fragrance, Lady Gaga vegan, and cruelty-free cosmetic brand: Haus Laboratories, or if considering natural cosmetics then Jessica Alba: Honest Beauty, which in its prospectus emphasises the importance of Jessica Alba’s role in brand awareness and company’s growth in domestic and international markets. The importance for cosmetics brand having celebrity brand ambassador can also be observed in numbers. Fenty Beauty recorded USD 72.0m in earned media value (via WWD) and according to Guardian within one month of release, Fenty Beauty’s sales were valued at USD 72m. Haus Labs was the third bestselling celebrity makeup brand of 2020, earning over USD 141.7m of media value. It was only behind Fenty Beauty and Kylie Cosmetics, as first and second place, respectively (via WWD). MADARA has also successfully utilised this strategy collaborating with Finnish blogger Noora Shingler, launching custom-made products for the Finnish market, which promoted the MADARA brand substantially and eventually, it has become the third best known organic cosmetics brand in Finland. MADARA plans to benefit from the powerful market trends. Besides its domestic market, Latvia, the Company’s core markets include Northern European countries, where demand is high for quality organic products as people in this region have high disposable incomes and more advanced online shopping habits. This does not in any way preclude efforts in other European countries, though a focus closer to home is natural in the short term, with further opportunities identified over the longer term. One of the main markets for MADARA is Finland, where the trend toward natural beauty and personal care products is becoming more mainstream. The use of natural products first emerged with smaller, organic, and premium brands, though it is now spreading to more widely used products. Natural ingredients have featured in the vast majority of new product launches, including those from leading mass brands, such as Unilever and L’Oréal. The competition is therefore intensifying, with several other international best-selling brands with innovative ingredients entering the Finnish market in recent years. Skincare, haircare, and makeup are widely using organic care products, collectively accounting for nearly four-fifths of the global organic personal care and cosmetic products market. The cosmetics industry is highly competitive, with the skincare segment set to remain the dominant part, accounting for nearly one-third of the market by 2022. According to many research reports, a larger, ageing population is helping drive growth in this segment, feeding off increased demand for natural and organic anti-ageing creams, moisturisers, and body lotions. Consumers perceive natural and organic products to be safer and of higher quality, with oils from natural sources such as argan, marula, almond, aloe vera, and coconut proving to be particularly popular ingredients for organic skincare products. For a variety of reasons, consumers are seeking ways of embracing a more natural lifestyle, a trend that also applies to cosmetics. Those with the money are moving away from mass-produced items toward those marketed as a part of a healthier, wellness-oriented lifestyle. This is a worldwide trend based on a preference for organic products that have been developed ethically and in an environmentally friendly way throughout the entire value chain. The visibility given to organic skincare products by the entry of large multinationals into the segment has generated additional demand and accessibility. Therefore, retailers who promote product quality, transparency, and sustainability are doing better than ever. Sustainability as a concept is growing in importance – consumers are becoming more aware of the term and show a preference for products manufactured under its principles: using renewable energy, recyclable packaging, and locally sourced ingredients. In response, the major brands operating in the industry are altering their product mixes, shifting the types of their ingredients used and acquiring natural skincare brands. The main advantages for the larger market players are that they produce natural cosmetics with advanced formulas at a lower cost. However, the higher costs of smaller manufacturers and, therefore, higher prices seem to have relatively little effect on consumer preferences, as they are willing to pay a premium for natural cosmetics. The rise of the individual consumer is an important trend underlying the shift in consumption patterns. After scientific research started highlighting the damage inflicted on the skin by environmental factors (radiation, free radicals and the like), antioxidants were hyped as potential offsets. This gave rise to the trend of using plants that contain very high concentrations of powerful antioxidants in skin creams. The key to success on the market seems to be in combining multiple antioxidants to provide the fullest spectrum of protection possible. According to Mordor Intelligence, the COVID-19 pandemic hurts the organic personal care products market in two main ways: 1) by directly affecting production and demand, and 2) by creating supply chain and market disruption, especially for natural ingredients. However, the pandemic has led to an increase in the use of e-commerce. Online distributors are recording an increased interest as homebound consumers explore retail alternatives. Some personal care product brands and retailers with inventory and shipment operations ready to scale up are reporting e-commerce sales twice as high as their pre-pandemic levels. For instance, Sephora’s US online sales were reportedly up 30% y-o-y in 2020. Similarly, e-commerce technology and digital marketing company ITCAN, has reported that online orders for skincare and makeup products in Saudi Arabia have soared up to 700% as consumers sought to avoid public places and online orders for skincare rose by 105.37%, with 32.7 % coming from new users, showing a conversion rate of 63.59%. A similar e-commerce growth trend was observed in the European region. The pandemic accelerated e-commerce meaningfully; the EU-27 retail sales via mail order houses or the internet increased by 30% y-o-y in April 2020, while total retail sales diminished by 17.9% (via OECD). It could be expected that this channel will continue to play a prominent role in the coming years. MADARA has also beneplay a prominent role in the coming years. MADARA has also benefit-

ted a lot from this development in the past two years and expects online channel to grow. Furthermore, the pandemic has led to a major consumer shift, as customers are no more brand loyal in developing countries and are trying new brands in the low-stock environment, which has resulted in new opportunities for many private players to emerge in these markets.

SWOT Analysis of MADARA Strengths MADARA has many strengths that differentiate it in the industry and serve as tools to promote growth. Consumers are gradually becoming more informed about the adverse effects of many synthetic chemicals used in daily use products and leaning towards the use of natural and organic origin products including cosmetics, that are friendlier to nature and the human body. Also, industry legislators are pushing towards safer cosmetics and packaging for consumers and the environment, and a meaningful contribution to both objectives is employing natural raw materials. MADARA possess very strong sustainability principles that are incorporated throughout its products and operations which is strongly valued by consumers. As the industry at certain extent already requires adapting products and aims to improve sustainability standards in future, MADARA is steps ahead of its competitors, which will allow continuing growth without disruptions. The Company’s vertical integration gives almost full control over all processes making its brand representation unique, ensuring seamless product quality and possessing fewer supply chain risks. With numerous awards and becoming a pioneer in a complex formula products, MADARA proves its R&D to be highly innovative, bringing demanded high value-added products to consumers. Unique marketing is a result of vertical integration, the Company has an in-house marketing team which is highly dedicated to developing MADARA’s brand and delivering a sophisticated brand image. The Company exploits diverse sales channels getting its products easily available to consumers. A strong online presence on the most popular cosmetics e-commerce platforms in the EU and its own direct e-commerce channel have become crucial for the Company’s sales growth as an increasing number of consumers prefer to shop cosmetics online. Also, its own e-commerce platform allows MADARA to effectively advertise itself with direct links on social media and other ad-supported apps and websites, as in the case of third-party retailers the initiative would have to come from them. Thus, MADARA is able to create unique and frequent product campaigns in a wide market spectrum, along with enhancing profitability. Opportunities Considering the gradual demand increase for natural and organic cosmetics and industry trends, MADARA has the opportunity to use its tools (strengths) and penetrate main cosmetic markets achieving growth and strengthening its position in the future. Increasing consumer preference for online shopping has been very beneficial for MADARA in terms of sales growth and profitability. This was possible because the Company had developed a convenient and widely available e-commerce channel. Also, with steep direct e-commerce channel growth, the Company has made a noticeable investment in its further development which will support further direct e-commerce channel growth. We believe that the COVID-19 pandemic has changed consumer shopping preferences that will continue going forward, of course, physical sales channels will see recovery at certain extent. Currently, there is an opportunity to maintain the existing consumer base in the online sales channel and cultivate more online traffic by developing the direct e-commerce channel which will convert into competitiveness, sales growth, and higher profitability. Weaknesses

MADARA had quite a successful cooperation with Noora Shingler, launching custom-made products for the Finnish market, which substantially promoted the MADARA brand and eventually, it has become the third best known organic cosmetics brand in Finland. Using brand ambassadors is one of the most preferred promotion tactics in the cosmetics industry due to its effectiveness. After successful results with the Noora project, we would like to see MADARA doing the same in other main markets like Germany, France, the UK etc. However, MADARA compared to its peers is a very small company and acquiring a highly recognised brand ambassador in markets like Germany, France, or the UK might be extremely expensive, thus it will be hard for the Company to apply this strategy in bigger markets.

Threats

The gradual increase in natural and organic cosmetics demand has been observed by the industry leaders which also have released natural and organic cosmetics lines. Leading mass brands have different strategies for entering the market, with one being acquisitions. Thus, the extent and pace of cosmetic giants entering the natural and organic cosmetic niche would be very decisive for MADARA’s growth and market position strengthening in the coming five years.

Internal Factors Strengths (+) Weaknesses (-) • Sustainable product and packaging • Limited brand ambassadors • Vertical integration • Innovative R&D • Unique marketing • Diversified sales channels

External Factors Opportunities (+) Threats (-)

• Market penetration • Utilizing direct e-commerce platform • Increased competition in natural/organic cosmetic segment from multinational corporations

Source: LHV