ULTA - Ulta Beauty: Recession Resistant And Positioned To Thrive

2023-04-26 13:42:07 ET

Summary

• Ulta Beauty has delivered years of strong growth over the past decade, and has demonstrated resilience even during times of economic weakness.
• The lipstick effect, and product range across various price points can help Ulta weather any recession.
• Store expansion efforts, sharpened focus on coveted Gen-Z shoppers, and their move up the luxury segment positions Ulta to deliver continued growth long term.

While a recession may be on the horizon , I believe America's biggest beauty retailer, Ulta Beauty ( ULTA ), could be worth a look.

Solid performance

After taking a hit during the pandemic, the beauty industry is now booming as lifting pandemic restrictions mean more occasions to use beauty products as workers return to work and social activities resume, driving sales for beauty retailers who have been clear beneficiaries despite inflation eating into consumers’ purchasing power; LVMH-owned Sephora saw a “ record performance ” in 2022, helping parent company LVMH ( LVMHF ) deliver double digit sales growth for the year. Ulta Beauty meanwhile saw sales increase 18% YoY to $10.2 billion while profits were up 26% YoY to $1.2 billion.

Ulta Beauty has a consistent track record of sales, profit growth, and margin expansion over the past decade. Looking ahead, there are several reasons to view Ulta Beauty’s stock favorably.

Recession may dampen growth but “lipstick effect” and Ulta’s broad product range can cushion any impact to consumer demand

Experts are divided as to whether the U.S. will head toward a recession; this month, JP Morgan said the U.S. is likely headed towards a recession, while in February this year, the head of the IMF said the U.S. can avoid a recession. Nevertheless, even if the U.S. does slide into a recession, a few factors could support Ulta Beauty’s performance, notably the “lipstick effect” as well as Ulta’s broad product range across various price points which should allow it to capture consumption downgrades.

The lipstick effect, coined by Estée Lauder's (EL) Leonard Lauder suggests that companies such as beauty retailers do well during challenging times, as consumers, forced to cut back on luxury products, turn to smaller luxuries such as lipstick. If history is any guide, Ulta Beauty could potentially deliver decent performance if a recession materializes; in 2008 for instance during the height of the Great Recession, Ulta Beauty’s sales increased 19% YoY, profits were unchanged (down 0.2%), and the company continued their store expansion efforts during the year with 63 new stores opened (and just 1 closed in 2008). Sales and profits promptly continued their upward march the following year, surpassing pre-recession figures.

Additionally, unlike rival Sephora which tends to carry prestige beauty brands, Ulta Beauty carries a broader range of products across a wider range of price points from prestige brands to budget-friendly options (Sephora has around 340 different brands while Ulta carries more than 600. Ulta Beauty is also ahead in terms of product range with an estimated 26,500 products versus 16,500 for Sephora), positioning Ulta Beauty to capture consumption downgrades as consumers switch to more affordable brands during economic weakness. According to a study, Sephora’s products are priced significantly higher than Ulta across all major categories, a factor that contributed to the latter’s superior performance during the pandemic; Ulta’s eCommerce sales rose 67% at Ulta versus 25% for Sephora as the former was more appealing to customers trying to control spending during the pandemic according to a report by 1010data.

Long-term growth opportunities

Expanding physical store footprint in the U.S. and expanding product range to support sales growth

With more than 1,350 stores across the U.S., versus 1,147 for Sephora, Ulta Beauty is already ahead in terms of store count but the beauty retailer has plans for further expansion; Ulta opened 47 stores in 2022 and renovated or relocated 32. The retailer plans to open 25 to 30 more stores (not including Ulta’s plans to expand its shop-in-shops with Target ( TGT )) as part of a long term plan to expand its total standalone store count to 1,500 - 1,700, and its Target shop-in-shops count to 800. Stores play a major role in driving sales as part of an omnichannel strategy and an expanding store count could support top line and bottom line growth going forward.

Alongside efforts to expand its store footprint, Ulta Beauty is constantly expanding product range showcasing new brands in a specific section of the store called Cue the New before transitioning them to other parts of the store alongside existing brands. New brands launched in Ulta Beauty in 2023 include Jennifer Aniston’s LolaVie brand, and D2C brands Beautycounter , Odele , Peace Out , Moon Juice , Coco & Eve , Solawave , and Bushbalm to name a few.

Strengthening efforts to lure Gen-Z

Gen Z consumers (those born between 1997 and 2012), although still young, are a coveted high-spending customer base growing in importance given their expanding purchasing power and influence as they rise up the income ladder in the years ahead. Gen Z’s beauty spending in the U.S. jumped 19% YoY in 2022 according to a Piper Sandler survey. Gen Z’s share of beauty spend worldwide is expected to grow in the long run.

Already among Gen Z’s favorite brands and the number 1 beauty retailer among Gen Z, Ulta Beauty has been taking steps to solidify their appeal with constant launches of Gen-Z focused new products and collaborations. From launches of Gen-Z brands such as Petite 'n Pretty and Byoma , to leveraging social media and technology to drive Gen-Z purchases , to doubling down on its luxury product offering partly in an effort to lure Gen Zs who together with millennials accounted for all of the luxury market’s growth last year according to Bain & Co.

Move towards the luxury segment could support sales growth and solidify appeal among Gen Z shoppers

Ulta Beauty launched a new luxury category this year offering luxury cosmetics brands such as Dior, Chanel, and Lancôme to name a few as well as fragrances from luxury brands such as Tom Ford, Givenchy, Yves Saint Laurent, Tiffany & Co, and Gucci. The effort could not only help Ulta Beauty capture a greater share of customers’ wallets (driving sales and profits in the process), but it could also help strengthen their appeal among Gen Z shoppers - an increasingly important customer base with a propensity for luxury products.

International expansion

Having conquered the U.S. beauty retail market (Ulta is America’s biggest beauty retailer and together with Sephora the duo dominate the beauty stores market in the U.S.), Ulta has had plans to expand internationally (starting off with Canada but plans were dropped due to the covid pandemic). Sephora has 2,700 stores in 35 countries around the world while Ulta has none . Ulta is operating cash flow positive, has decent cash reserves to cover short term liabilities (current ratio 1.6 , quick ratio 0.66 ), and has no debt (most of their long term liabilities are made up lease liabilities) which gives them tremendous financial flexibility to fund international expansion efforts.

Risks

Stiff competition

Sephora and Ulta differentiated themselves across many areas notably in that Sephora tended to carry prestige brands while Ulta carried a broader product offering with a wider breadth of price points and Sephroa’s physical stores tended to be located in malls while Ulta was located in convenient strip centers. Sephora however is now forcefully moving into strip centers while Ulta is moving up the luxury segment, stepping into each other's turf and intensifying competitive pressures in the process.

Conclusion

Ulta has delivered consistent growth over the past decade, has historically fared decently during times of economic weakness and is positioned to thrive longer term when the economy recovers; Ulta is estimated to have a higher market share than Sephora ( 9% for Ulta versus 6% for Sephora) and the retailer’s differentiated business model (Ulta is one of the few beauty retailers that sells both mass-market and prestige beauty brands under one roof, a major competitive differentiator in a highly competitive market), and growth initiatives including an expanding store count, expansion into the luxury segment and efforts to capture a greater share of Gen Z’s beauty spend positions Ulta to benefit long term.

Analysts are moderately bullish on the stock.

Ulta’s P/E of 21 is not cheap compared to the sector average but could be considered fair for a market leader growing at double digits. Moreover, the stock is quite cheap compared to its historical average. Some may view the stock as a buy while others may view it as a hold.

For further details see: