2023-08-03 22:00:02 ET
Summary
- Ulta Beauty operates in the large and growing US beauty products and salon services industry, with a 9% market share.
- The company has a strong customer loyalty base and a best-in-class loyalty program, with its members accounting for 95% of sales.
- Ulta provides a seamless shopping experience through its store footprint, digital platform, and personalized offerings, giving it a competitive advantage.
- Growth amongst many key financial indicators like free cash flow has been quite strong and sustained since 2014.
Overview
Ulta Beauty Inc. ( Ulta) operates within the large and growing U.S. beauty products and salon services industry. This market reached $172 billion dollars in sales in 2022, according to Euromonitor International and IBIS World Inc. Additionally, in 2022, the beauty products market was valued at $104 billion dollars, with Ulta's management believing to hold around a 9% market share in the industry. The company's main competitors include traditional department stores, specialty stores, grocery stores, drug stores, mass merchandisers, as well as e-commerce platforms of pure-play e-commerce companies and national retailers. Ulta also operates in and competes with chain and independent salons in the salon services and products market.
Customer Loyalty
Ulta is the largest specialty beauty retailer in the United States, selling cosmetics, fragrances, skin care products, hair care products, and salon services. Founded in 1990, Ulta Beauty has developed a unique specialty retail concept that offers a wide range of brands at different price points for their target customer base, which they call “beauty enthusiasts”, a consumer that is passionate about the beauty category and uses beauty for self-expression and self-investment.
This is is a large customer base to cater to, and Ulta Beauty does a great job of serving their needs. They estimate that these beauty enthusiasts make up around 80% of beauty product and service spending in the United States and account for 65% of their sales.
The company's assortment of over 25,000 beauty products from over 600 beauty brands across a variety of price points and categories gives shoppers plenty of options to choose from and help appeal to the largest possible market. Ulta carries the widest range of beauty products on the market, giving it a notable competitive advantage. With such a wide range of products to choose from, customers keep coming back to Ulta through a best-in-class loyalty program. Ultamate Rewards, their loyalty program, allows shoppers to earn points on every dollar they spend on products and beauty services. These points can be redeemed for discounts on any product or service at store locations.
With more than 95% of total sales coming from members, Ulta Beauty has one of the largest moats within the specialty retail space as their customer base is seemingly so loyal. With such a deep understanding of their customer’s preferences and behaviors, Ulta Beauty is able to efficiently and effectively personalize shopper experiences, recommendations, and promotions for customers.
Shopping Experience
In addition to understanding their customer base well, the company's store footprint and leading digital experience offered through its website and mobile application provide customers with value through a seamless shopping experience. Ulta operates over 1,350 free standing locations, often located in high-traffic locations. In addition to these stand alone locations, they offer 350 locations within Target stores that offer customers curated prestige beauty product offerings. With their bright, open store design, customers are easily able to discover new products and services. Additionally, the store’s open layout makes it flexible and easy to change in response to consumer preference changes and changes in merchandising strategy, allowing the company to operate their stores efficiently.
Ulta offers a personalized and innovative digital experience for customers. Shoppers are given an array of fulfillment options (buy online pick-up in store, buy online pickup curbside, ship from store, ship from distribution center, and same-day delivery) that give customers essentially whatever they might want. Additionally, Ulta's innovative digital experiences (virtual try-on and skin analysis tools) leverage augmented reality and artificial intelligence technology to provide customers with personalized experiences, further showing their commitment to giving customers the best experience possible when shopping online or in their stores. This calculated dedication to customer’s has clearly paid off, and we believe that it will continue to be a strong competitive advantage for them.
Priority on Shareholder Satisfaction & Growth
As mentioned above, with 95% of sales coming from 40.2 million active Ultamate Rewards loyalty program users and strong customer research capabilities, Ulta Beauty knows its customers better than anyone else. With these research capabilities, Ulta Beauty has acknowledged that social media and influencers play a big part in their customers connection to beauty. Ulta plans to build out their brand and build a creator and content ecosystem to deliver compelling beauty entertainment in an effort to drive brand awareness. Additionally, they plan to continually innovate the Ultamate Rewards loyalty program.
Ulta seems to understand that customers enjoy the experience of trying and discovering new products. They plan to engage customers and drive growth by optimizing key categories (makeup, skincare, haircare, and fragrance), investing in cross-category strategic platforms (Conscious Beauty at Ulta Beauty, the Wellness Shop, and SPARKED at Ulta Beauty), and differentiating their product assortment through exclusive brands and products (i.e. Ulta Beauty Collection, their private label). Management understands that cost pressures from rising wages, transportation, and so on are dampening growth. As a result they they plan on enhancing their supply chain network to increase agility and cost-efficiency.
Management is solid and their capital allocation priorities are shareholder friendly. In March of 2022, the Board of Directors authorized a 2022 share repurchase program where the company could repurchase up to $2 billion dollars worth of shares. During the fourth quarter of 2022, management executed on this agreement and repurchased 722,983 shares at an average price of $454.20 dollars per share for a total of around $328.6 million. As of January 2023, there was still $1.1 billion dollars remaining for share repurchases.
In addition to these large share buybacks, management is also incentivized well. Named Executive Officers are compensated with a yearly cash base salary, annual cash incentive plan bonus based on an EBT (earnings before taxes) goal, and a long-term incentive plan that rewards NEOs in performance based shares (50% of award value), stock options (30% of reward value), and RSUs (20% of reward value) based on EBT and revenue growth goals. With around 90% of shareholders voting in favor of this executive compensation plan, it seems like shareholders are more than happy with Ulta Beauty’s executive payment plans which incentivize earnings and revenue growth.
Strong Sustained Growth Across Key Financials
Overall, Ulta is quite an efficient business. It operates at a ROIC of 41.3% and a ROE of nearly 67%. With a WACC of 9.9%, Ulta Beauty has a ROIC to WACC ratio of around 4x, demonstrating the business’ ability to generate returns greater than their cost of capital. With such an efficient business, they're able to reinvest cash back into the business at favorable rates of return, compounding company value and rewarding shareholders. A double win.
Upon looking at their income statement, we see some stellar sustained growth in revenue, gross profit, and earnings. Since 2014, Ulta grew its revenue at a CAGR of around 16%. They've also grown their gross profit at a CAGR of 19% in the same time frame. This large increase in gross profit over the last decade can largely be attributed to expanding gross margins. In 2014, gross margins sat at 35%, whereas now they sit at 43.5%. In regards to earnings they've grown EPS and EBITDA at high CAGRs throughout this decade. Since 2014, EPS has grown at a CAGR of around 26%, with EBITDA growing at a CAGR of around 18%. The EPS growth this decade is largely in part due to share buybacks. Since 2014, shares outstanding have fallen around 22% from 64.3 million to 49.8 million today.
The company has no long term debt and holds around $636.5 million dollars worth of cash and cash equivalents on hand. Additionally, like mentioned before, the company is consistently buying back shares to return excess cash to shareholders.
Since 2014, Ulta Beauty has grown its net income at a CAGR of around 22%, with free cash flow growing at a CAGR of 29% in that same time period. This increase in free cash flow can largely be attributed to expanding free cash flow margins. In 2014, free cash flow margins represented 3.8% of revenue, compared to today where LTM free cash flow margins represent around 10% of revenue. As we can see, Ulta Beauty operates very efficiently and is able to generate large amounts of cash from its operations, which it can then use to reward shareholders via dividends, share buybacks, or reinvestments back into the business that allow it to rapidly compound its intrinsic value, increasing shareholder value.
Reverse Discounted Cash Flow Model
After conducting a reverse discounted cash flow model analysis, we can see that Ulta trades at share prices that imply a 9.65% growth rate in free cash flow over the next 10 years, at a perpetuity growth rate of 3% (largely in line with US GDP growth) and the discount rate at 10%. Like we discussed, the company has grown its free cash flow at a rate of 29% since 2014, mostly thanks to growing margins, as discussed above. With a free cash flow growth rate that high over the past 9-10 years, it seems that a 9.65% free cash flow growth rate is cheap, however, there are a multitude of factors to consider. If free cash flow margins gradually expand over the next 10 years, then this may be an attractive price to open a position. However, if free cash flow margins stay flat and/or decline, or other headwinds affect Ulta's business model, putting strain on it’s ability to generate cash from operations, then this current implied growth rate may be high.
For further details see:
The Bull Case For Ulta Beauty