2023-10-10 09:51:04 ET
Summary
- Ulta Beauty is the largest beauty retailer in the US, offering a wide range of beauty products and services.
- The company has experienced underperformance in recent quarters, with lower profit margins and weaker sales growth.
- Ulta Beauty's loyalty program, Ultamate Rewards, has been successful in driving customer satisfaction and growth, supporting the company's future prospects.
Company Overview
Ulta Beauty ( ULTA ) is the largest beauty retailer in the United States, with over 1,300 stores nationwide. The company offers a wide range of beauty products and services, including cosmetics, skincare, fragrances, haircare, and salon services. Ulta Beauty is known for its convenient one-stop shopping experience, its broad assortment of products from both drugstore and luxury brands.
Ulta Beauty was founded in 1990 and has since grown to become a major player in the beauty industry. The company's success is due in part to its unique business model, which combines a broad assortment of products with a wide range of services. Ulta Beauty's stores are typically large and well-lit, with a wide variety of beauty products on display. The company also offers a variety of salon services, such as haircuts, styling, and makeup applications.
Ulta Beauty provides a variety of products in six main categories: cosmetics is the largest with 42% of total net sales, beauty products and hair styling tools with 21% of total net sales, skin care with 17% of total net sales, fragrances and bath 14% of total net sales, services It is the smallest category with 3% of total net sales, accessories and others also with 3% of total net sales.
Underperformance YTD
Historically, the relationship between beauty spending and economic conditions has not weakened in softer economic environments, and our proprietary consumer research confirms that engagement in the beauty category remains strong. However, Ulta Beauty began to underperform after the first quarter of fiscal 2023, despite meeting or exceeding revenue and earnings estimates. This suggests that there may be other factors at play, such as increased competition or changes in consumer behavior.
- Lower-than-expected profit margins. Ulta's operating margin for the quarter was 16.8%, down from 18.7% in the prior-year period. This was due to several factors, including higher inventory shrink, lower merchandise margins, higher supply chain costs, and rampant salon spending.
- Weaker-than-expected sales growth. Ulta's comparable sales growth for Q1-23 was 9.3%, down from 18.0% in the prior year period. This was likely due to several factors, including rising inflation, supply chain disruptions, and the ongoing COVID-19 pandemic.
- Guiding for lower-than-expected profit margins for the full year. Ulta's management lowered its guidance for fiscal 2023 operating margin to 14.5%-14.8%, down from its previous guidance of 14.7%-15.0%. This was due to the same factors that impacted profit margins in Q1.
In addition, I believe that increased competition from both online and offline retailers is putting pressure on Ulta Beauty's margins and sales growth. Online retailers like Amazon and Sephora are becoming increasingly popular, as they offer a wide selection of products at competitive prices. Additionally, brick-and-mortar retailers such as Target (TGT) and Walmart (WMT) are expanding their beauty offerings.
Ulta's margins decline (Ulta's earnings release)
The stock price fell 6.5% in Q2-23 after the earnings release , which also showed a decline in margins from the prior-year period.
Ulta Margins
Ulta's Margins (Compiled by the author using data from Ulta Beauty financial reports)
In the last two quarters, we have seen a decline in margins, partly due to inflation. However, over the past seven years, we have seen an uptrend in Ulta's profitability. I believe that Ulta's management has the knowledge and experience to improve profitability in the coming years, for the following reasons:
- Track record of success. Ulta's management team has a proven track record of success. Under the leadership of CEO Dave Kimbell, Ulta has grown into one of the largest and most profitable beauty retailers in the United States. Over the past seven years, Ulta's revenue has increased from $3.2 billion to $8.6 billion, and its operating margin has increased from 12.5% to 16.8%.
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Deep understanding of the beauty industry. Ulta's management team has a deep understanding of the beauty industry and the needs of its customers. The company has a strong relationship with its suppliers and is able to negotiate favorable terms. Ulta also has a strong brand and a loyal customer base.
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Focus on innovation. Ulta is constantly innovating to meet the needs of its customers. The company was one of the first retailers to offer a wide selection of prestige beauty products at affordable prices. Ulta has also been a leader in the omnichannel retail space. The company offers a seamless experience for its customers, both online and in-store.
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Strong execution. Ulta has a strong track record of executing its plans. The company has consistently met or exceeded its financial guidance in recent years.
In addition to the above, Ulta's management team is also taking steps to address the challenges that the company is facing, such as increased competition and rising costs. For example, Ulta is launching its own private label brands and expanding into the prestige beauty market. The company is also investing in its omnichannel capabilities and its loyalty program.
Ulta's Balance Sheet
Ulta Beauty has a strong balance sheet, with a current ratio of 1.61 and a debt-to-equity ratio of 0.97 for fiscal 2023. This means that the company has enough current assets to cover its current liabilities by 1.61 times, and it has slightly more equity than debt.
The current ratio is a measure of a company's ability to meet its short-term financial obligations. A current ratio of 1.61 is considered to be good, and it suggests that Ulta Beauty is able to meet its short-term financial obligations without any difficulty.
The debt-to-equity ratio is a measure of a company's financial leverage. A debt-to-equity ratio of 0.97 is considered to be conservative, and it suggests that Ulta Beauty is not excessively reliant on debt to finance its operations.
Overall, Ulta Beauty has a strong balance sheet, with both good liquidity and a conservative capital structure. This is a positive sign for investors, as it suggests that the company is well-positioned to withstand economic downturns and continue to grow in the future.
Ulta Beauty's ROCE for the most recent fiscal year (2023) at 44.42% is significantly higher than the ROCE of its peers, such as Sephora (35.2%) and Estée Lauder (28.7%). This suggests that Ulta Beauty is generating a great return on its invested capital. Additionally, Ulta Beauty's ROCE has been consistently high in recent years, increasing from 43.1% in fiscal year 2022 to 44.42% in fiscal year 2023.
Ulta Beauty's strong balance sheet and high ROCE position the company well for future growth. The company has the financial resources to invest in new growth initiatives, while its ability to generate good returns on its investments will help to drive future growth. Investors benefit from these factors through a reduced risk of bankruptcy and the potential for higher stock prices and dividends.
Ulta Beauty Loyalty Program
Ulta's Loyalty Program (Ulta's presentation)
Ulta Beauty's loyalty program, Ultamate Rewards, allows members to earn points for every dollar spent on products and beauty services at Ulta Beauty, through purchases on Ulta Beauty's private label and co-branded credit cards, and purchases at Ulta Beauty at Target. Over 95% of total sales come from members. This program allows Ulta to gain a deep understanding of its customers and their preferences, enabling Ulta to personalize experiences, recommendations, and promotions through its Customer Relationship Management ((CRM)) platform and support the growth of its brand partners. For example, Ulta Beauty member data confirms that beauty enthusiasts prefer to shop in physical stores, where they can discover and interact with products and other beauty enthusiasts. 76% of loyalty members transact only in Ulta Beauty stores.
Ulta's Loyalty Program Members (Ulta's presentation)
Over the years, Ulta Beauty's members have consistently expressed satisfaction with the Ultamate Rewards program, as evidenced by the increase of 8 million members from 2018 to 2022. I believe that this trend will continue in the coming years, given the satisfaction of existing customers and the continued growth of the beauty market.
Valuation
Authored using Ulta Beauty financial data and the author's projections
I used a discounted cash flow ((DCF)) methodology to estimate Ulta's fair value. I assumed that the company would grow its revenue at a compound annual growth rate ((CAGR)) of 5.7% between 2024 and 2030, based on their unique Loyalty program and expansion in stores. Using a weighted average cost of capital ((WACC)) of 10.3% and factoring in Ulta's net debt position, I estimated the company's fair value to be $407 per share.
Based on my 2024 EPS forecast, the valuation reflects a forward P/E of 14.66x, which is above consensus due to strong share buybacks.
Author's assumption (Created and calculated by the author)
Based on Ulta Beauty's Q2-23 results , I project that the company will generate revenue of $2,449 million in Q3-23, which is in line with the consensus forecast. I also estimate that the operating profit margin will decline to 13.5% in Q3-23, due to inflationary pressures.
After adjusting my model to reflect Ulta Beauty's Q2-23 results, I now expect the company to generate full-year revenue of $11.01 billion in 2023, which is consistent with the company's guidance. This represents a growth of 7.8% from the company's revenue in 2022.
Risks & challenges
- Competition: Ulta Beauty faces significant competition from other beauty retailers, such as Sephora ( LVMUY ), ( CVS ), and Walgreens ( WBA ), as well as from online retailers, such as Amazon ( AMZN ). The company must continue to innovate and differentiate itself in order to maintain its competitive advantage.
- Economic downturn: A recession or economic downturn could lead to a decline in consumer spending on beauty products. Ulta Beauty's sales would likely be impacted by such an event.
- Supply chain disruptions: Ulta Beauty relies on a complex global supply chain to source its products. Disruptions to this supply chain, such as those caused by the COVID-19 pandemic or the war in Ukraine, could lead to shortages of products or higher costs.
- Labor shortage: Ulta Beauty, like many other retailers, is facing a labor shortage. This could make it difficult to find and retain qualified employees, and could also lead to higher labor costs.
- Shift to online shopping: Consumers are increasingly shopping online for beauty products. This trend could put pressure on Ulta Beauty's brick-and-mortar stores.
Conclusion
Ulta Beauty is the largest beauty retailer in the United States, with a strong track record of growth and profitability. The company's unique business model, which combines a broad assortment of products with a wide range of services, has been key to its success.
Despite the challenges facing the company, such as rising inflation and supply chain disruptions, I believe that Ulta Beauty is well-positioned for long-term growth. The company has a strong brand, a loyal customer base, and a management team with a proven track record. Ulta Beauty is also investing heavily in its omnichannel capabilities, which will help it to compete more effectively in the online market.
In addition to the company's strong fundamentals, Ulta Beauty also has a healthy balance sheet and a high ROCE. For fiscal 2023, the company had a current ratio of 1.61 and a debt-to-equity ratio of 0.97. This suggests that the company has enough current assets to cover its current liabilities by 1.61 times, and it has slightly more equity than debt. Ulta Beauty's ROCE for the same fiscal year was 44.42%, which is a very high ROCE and suggests that the company is generating a great return on its invested capital.
These strong financial metrics further support my investment thesis that Ulta Beauty is a well-managed company with a bright future.
Overall, I believe that Ulta Beauty is currently trading at a discount to its fair value. I have a price target of $407 per share and give Ulta Beauty a Buy rating.
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Ulta Beauty: A Beauty Stock That's About To Pop