Executive Summary / Key Takeaways

• Skincare-Led Margin Inflection: Yatsen Holding's three-year strategic transformation has shifted revenue mix from color cosmetics to skincare brands (Galénic, DR.WU, Eve Lom), with skincare reaching 49.2% of total revenue in Q3 2025 and driving non-GAAP profitability for three consecutive quarters—a structural improvement that directly addresses the company's historical profitability challenges.

• R&D as Defensive Moat: Heavy investment in R&D (3.2% of 2024 revenue) and world-class infrastructure (Shanghai R&D center accredited in Q1 2025) is creating scientifically credible products that compete with foreign high-end brands while maintaining pricing discipline, evidenced by gross margins expanding to 78.2% and hero products ranking #1 across major e-commerce platforms.

• 2025 Revenue Re-acceleration: After a flat 2024, total net revenues accelerated to 47.5% year-over-year growth in Q3 2025, significantly exceeding management's guidance range of 15-30%, with skincare brands growing 83.2%—demonstrating that the transformation is not just margin-accretive but also driving top-line momentum.

• Competitive Pressure Intensifying: Management explicitly acknowledges that foreign high-end brands are "struggling with very big O2O price up the hero product" during Double Eleven, creating both opportunity (market share gains for YSG) and risk (margin pressure if price competition escalates), particularly as YSG's high-end skincare brands grow faster and attract more attention from global incumbents.

• Valuation Hinges on Execution: Trading at 0.91x sales with negative earnings but improving cash generation, YSG's valuation requires sustained 15-30% revenue growth and continued margin expansion to be justified, making execution on skincare portfolio expansion and color cosmetics stabilization the critical variables for investors.

Setting the Scene: The Digital-Native Challenger Undergoing Category Surgery

Yatsen Holding Limited, founded in 2016 as Mangrove Bay Ecommerce Holding (Cayman) and renamed in January 2019, began as a digitally native color cosmetics company built for China's social commerce era. The company's initial success with Perfect Diary leveraged KOL marketing and rapid product iteration to capture Gen Z consumers, but this model proved vulnerable as China's beauty market matured and competition intensified. By 2020, YSG's financial performance established a baseline that would soon be tested by market headwinds and strategic necessity.

The China beauty market, a $78 billion arena by 2025, has long been dominated by foreign high-end brands in the premium segment while local players like Proya (603605.SS) and Shanghai Jahwa (600315.SS) competed in mass-market tiers. YSG positioned itself as a challenger bridging both worlds—trendy and affordable color cosmetics with aspirations for premium skincare credibility. However, the market's evolution toward rational consumer purchasing and intensified price competition exposed the limitations of a color cosmetics-heavy portfolio: lower margins, higher promotional intensity, and fierce competition from both local peers and global incumbents.

This context explains why YSG embarked on a deliberate three-year strategic transformation to rebalance its portfolio toward skincare. The move wasn't cosmetic; it was surgical. Skincare offers fundamentally different economics: higher gross margins, stronger customer loyalty, scientific credibility that supports premium pricing, and a more defensible competitive position through R&D. By 2024, this transformation reached an inflection point, with skincare brands reaching 41.1% of revenue despite a subdued overall beauty market that declined 1.1% for the full year.

Technology, Products, and Strategic Differentiation: Building Scientific Credibility

YSG's R&D strategy represents a radical departure from typical C-beauty companies that rely on marketing-driven brand storytelling. The company invested in building world-class R&D infrastructure, with its Guangzhou R&D center receiving CMAS accreditation in 2022 and its Shanghai global R&D center opening in 2024, achieving China National Accreditation Service conformity assessment in Q1 2025. This isn't window dressing—it enables YSG to develop clinically validated products that compete on efficacy, not just aesthetics.

Galénic exemplifies this approach. The brand's #1 VC serum maintained market leadership while launching a #2 VA serum, both ranking among top-selling serums across major e-commerce platforms in Q3 2025. The newly introduced #3 VB7 serum, launched in mid-September 2025, quickly became a best-seller on Douyin. More importantly, YSG is seeing "encouraging signs of regimen adoption, with more consumers purchasing multiple products within the series," which directly supports stronger customer lifetime value and reduces customer acquisition costs. The brand's offline expansion into experience stores in Guangzhou, Shanghai, Wuhan, and Shenzhen by June 2025 strengthens brand visibility and deepens consumer engagement beyond digital channels.

DR.WU leverages clinical credibility through its mandelic acid leadership and research presentations at dermatology conferences. In Q3 2025, the brand unveiled its first anti-aging product, TDI N Serum, in the UK, gaining strong traction across e-commerce platforms. The third Bakuchiol acne research fund project, launched in March 2025 and led by 14 dermatologists, has reached over 20,000 doctors and received over 350 clinical research proposals since 2023. This clinical grounding creates switching costs and supports premium pricing in a way that color cosmetics cannot.

Perfect Diary's transformation under the "makeup skinification" philosophy demonstrates YSG's ability to apply R&D innovation across categories. The Biolip Essence Lipstick, launched in September 2023, and its third-generation biotech technology applied to facial makeup (Biophased Essence Foundation) have driven the base makeup category to exceed 40% of total sales in Q3 2025. This shift from decorative color to functional makeup with skincare benefits captures the same margin-expansion logic as the skincare pivot while leveraging Perfect Diary's brand equity.

Why does this R&D focus matter? It transforms YSG from a marketing-driven cosmetics company into a science-driven beauty enterprise. This enables pricing power (gross margins expanded to 78.2% in Q3 2025), customer loyalty (evidenced by regimen adoption), and defensibility against foreign brands that compete on heritage rather than innovation. The 3.2% R&D investment ratio in 2024, while modest compared to pharma, is substantial for beauty and signals management's commitment to building durable competitive advantages.

Financial Performance & Segment Dynamics: Evidence of Structural Improvement

The financial trajectory tells a story of successful transformation. In 2024, total net revenues declined only 0.6% year-over-year despite the broader market's weakness, while skincare revenues grew 0.7% and reached a record 41.1% of the mix. This stability during a downturn demonstrated the skincare portfolio's resilience. More importantly, profitability improved materially: gross margin increased from 73.6% to 77.1%, and the company achieved its lowest full-year net loss since 2020, with non-GAAP net loss margin improving to 3.8% from 8.7% in 2023. Q4 2024 marked a turning point with non-GAAP net income margin hitting 9.3%.

The acceleration in 2025 is striking. Q1 delivered 7.8% revenue growth with skincare surging 47.7% and non-GAAP net income of RMB 7.1 million—a dramatic turnaround from an RMB 83.8 million loss in the prior year period. Q2 accelerated further to 36.8% total revenue growth, with skincare up 78.7% and the company achieving a non-GAAP net profit margin of 1.1%. Q3 hit 47.5% total growth, with skincare up 83.2% and reaching 49.2% of revenue, while net loss margin narrowed to 7% from 17.9% in the prior year period.

Segment dynamics reveal the engine of this improvement. Skincare brands (Galénic, DR.WU, Eve Lom) grew combined revenue by 88.1% in Q2 2025 and 58% in Q1 2025. This matters because skincare carries higher gross margins and creates more sustainable growth through repeat purchases. As management stated in Q3 2025, "the strong growth from skincare is a key driver of momentum, reinforcing the company's transformation toward a more sustainable, margin-accretive portfolio."

Color cosmetics, meanwhile, is stabilizing. Perfect Diary returned to growth in Q2 2025 (8.8% year-over-year) after a 9.9% decline in Q1, driven by the "makeup skinification" strategy. In Q3, base makeup exceeded 40% of total sales, and the brand achieved #1 ranking among makeup brands on WeChat video channel. This stabilization is crucial because it prevents the color cosmetics segment from becoming a drag on overall performance while the skincare transformation continues.

Cash flow dynamics reflect seasonal patterns and improving efficiency. Net cash used in operating activities was RMB 126.8 million in Q3 2025, compared to RMB 175.9 million in the prior year period. Management attributes this to working capital movements ahead of Double Eleven, which are "seasonal and planned effects" that will convert into revenue in Q4. The improvement from cash usage to generation in Q1 and Q2 (RMB 23.8 million and RMB 77.7 million generated, respectively) demonstrates that the business model is becoming self-funding. Cash, restricted cash, and short-term investments stood at RMB 1.1 billion as of September 30, 2025, providing adequate liquidity for the transformation.

Outlook, Management Guidance, and Execution Risk

Management's guidance for 2025 projects total net revenues between RMB 1.32 billion and RMB 1.49 billion, representing 15% to 30% year-over-year growth. This guidance, issued after Q3's 47.5% actual growth, appears conservative—a signal that management is prioritizing profitable growth over market share grabs. As CFO Donghao Yang stated in Q3, "we expect further improvement to be driven by a higher skincare mix, ongoing gross margin optimization, and greater marketing efficiency."

The commentary reveals key assumptions. Management expects the beauty market's headwinds to persist, with "price competition intensified and the consumer more rational in purchase decisions." This means growth must come from market share gains rather than category expansion. The strategy relies on three pillars: (1) continued skincare portfolio expansion and hero product development, (2) improving marketing efficiency through data-driven CRM and better ROI discipline, and (3) operational leverage as top-line growth continues.

Execution risks are material and explicitly acknowledged. In Q3 2025, management admitted that "we expect more competition from international brands as its high-end skincare brands grow faster." This creates a delicate balance: YSG must invest in brand building and R&D to compete with L'Oréal (OR.PA) and Estée Lauder (EL) while maintaining pricing discipline. The Double Eleven observation that foreign brands are "struggling with very big O2O price up the hero product" suggests an opportunity, but also risk—if YSG matches promotional intensity to gain share, margins could compress.

The dependency on digital platforms like Douyin and Tmall creates concentration risk. While YSG's digital-native model provides agility, algorithm changes or increased traffic acquisition costs could erode marketing efficiency. Management's focus on "shifting spending towards higher return channels" and expanding offline presence (Galénic experience stores, Perfect Diary's offline distribution growth) is a deliberate mitigation strategy, but the transition will take time.

Risks and Asymmetries: What Could Break the Thesis

Foreign high-end brand retaliation represents the most immediate risk. As YSG's skincare brands gain share, incumbents like L'Oréal (OR.PA) and Estée Lauder can leverage deeper pockets for marketing blitzes and promotional wars. Management's Q3 2025 comment that "the price competition will be intensified" isn't hypothetical—it's already happening. If YSG responds by increasing promotional spend to defend share, the non-GAAP profitability achieved in 2025 could reverse.

Digital platform dependency creates vulnerability. YSG's growth has been fueled by Douyin and Tmall, where it achieved #1 rankings. However, these platforms control the algorithms and can raise traffic acquisition costs at will. The Q3 2025 operating cash flow usage of RMB 126.8 million ahead of Double Eleven illustrates the working capital intensity required to compete during key shopping festivals. If platform economics deteriorate or consumer attention shifts, YSG's growth engine could stall.

Scale disadvantage versus key competitors limits bargaining power. Proya (603605.SS) generates $27 billion in enterprise value with 20.29% operating margins and 30.25% ROE, while Shanghai Jahwa (600315.SS) commands $15 billion enterprise value. YSG's $405 million enterprise value and -8.37% operating margin reflect its smaller scale and earlier stage of transformation. This size gap means competitors can outspend on R&D, marketing, and distribution. While YSG's digital agility provides some offset, the scale disadvantage could prevent it from achieving the same margin structure as Proya or L'Oréal.

Geopolitical and liquidity risks are unique to YSG's NYSE listing. As a Cayman-incorporated company with primary operations in China, YSG faces potential delisting risks and regulatory scrutiny. While the $30 million share repurchase program approved in May 2025 signals confidence, the -2.11 beta indicates high volatility and potential correlation with China-US tensions. Any deterioration in relations could impact the stock's trading liquidity and valuation multiple.

Asymmetry to the upside exists if YSG executes flawlessly. If skincare mix exceeds 50% and color cosmetics stabilizes above 2024 levels, gross margins could approach 80%, driving non-GAAP net margins into double digits. The R&D pipeline could yield breakthrough products that command premium pricing, while offline expansion might reduce digital dependency. In this scenario, YSG would transition from a loss-making challenger to a profitable, high-growth beauty company worthy of a premium multiple.

Valuation Context: Pricing in the Transformation

At a recent price of $5.60 per share, YSG trades at 0.91x price-to-sales ratio with a market capitalization of $526.42 million and enterprise value of $404.99 million. This valuation reflects a company still transitioning from loss-making to profitable, but the metrics require careful interpretation given the stage of transformation.

Revenue multiple analysis shows YSG trades at a discount to profitable peers. Proya commands 17.19x price-to-sales and 16.87x enterprise-to-revenue, while Shanghai Jahwa trades at 18.56x price-to-sales. L'Oréal, the global leader, trades at multiples that reflect its premium positioning and profitability. YSG's 0.91x multiple suggests the market is pricing in execution risk and uncertainty about the sustainability of its turnaround.

Cash position and burn rate provide a more nuanced picture. With RMB 1.1 billion (approximately $155 million) in cash and short-term investments as of September 30, 2025, YSG has adequate liquidity relative to its quarterly operating cash flow patterns. The company generated cash in Q1 and Q2 2025 but used cash in Q3 due to seasonal inventory buildup ahead of Double Eleven. This pattern suggests the business is approaching self-funding status, with full-year 2025 likely to show positive operating cash flow if Q4 converts inventory to revenue as management expects.

Path to profitability signals are encouraging but early. Gross margin expanded to 78.26% in Q3 2025, approaching levels seen at Proya (72.85%) and L'Oréal (74.11%). The non-GAAP net income achieved in Q1 and Q2 2025, while modest, represents a decisive break from the consistent losses of prior years. Marketing efficiency improvements—evidenced by reduced marketing spend as a percentage of revenue while maintaining growth—suggest the company is learning to scale without proportional increases in customer acquisition costs.

Balance sheet strength provides strategic flexibility. With debt-to-equity of only 0.06 and a current ratio of 3.06, YSG has minimal financial leverage and strong liquidity. This positions the company to invest through cycles, fund R&D initiatives, and potentially acquire complementary brands. The $30 million share repurchase program, while small relative to market cap, signals management's confidence that the stock is undervalued relative to the transformation's potential.

Observed patterns for similar business models suggest that successful beauty transformations can command premium valuations once profitability is established. Proya's evolution from a mass-market player to a skincare-focused leader with 20%+ operating margins supports the thesis that category mix shift drives multiple expansion. For YSG, the key is sustaining the skincare growth trajectory while achieving consistent non-GAAP profitability—if it can deliver 15-30% revenue growth with expanding margins in 2025, the 0.91x sales multiple would likely re-rate toward peer levels of 2-4x sales, implying significant upside.

Conclusion: The Skincare Transformation's Defining Moment

Yatsen Holding has engineered a remarkable turnaround by executing a deliberate strategy to transform from a marketing-driven color cosmetics company into an R&D-led skincare enterprise. The financial evidence is compelling: skincare mix approaching 50%, non-GAAP profitability achieved, gross margins expanding to 78%, and revenue re-accelerating to 47.5% growth in Q3 2025. This isn't a promotional story—it's a structural transformation that directly addresses the profitability and defensibility challenges that plagued the company historically.

The central thesis hinges on whether YSG can sustain this momentum while navigating intensifying competition from foreign high-end brands and managing digital platform dependencies. Management's guidance of 15-30% revenue growth for 2025 appears conservative given Q3's 47.5% performance, but this conservatism may reflect prudent planning for a persistently rational Chinese consumer and escalating price competition. The R&D moat—anchored by accredited global R&D centers and clinically validated hero products—provides the best defense against margin compression and the best offense for market share gains.

For investors, the valuation at 0.91x sales offers an asymmetric risk/reward profile. Downside is mitigated by strong cash position, minimal debt, and improving cash generation. Upside depends on execution: sustaining skincare growth above 50%, stabilizing color cosmetics, and delivering consistent non-GAAP margins above 5%. If YSG achieves these milestones, the multiple should re-rate toward profitable beauty peers, rewarding patient shareholders who recognized that the skincare transformation is not just a strategy slide—it's a fundamental rewiring of the company's economic engine.