2023-08-09 12:22:51 ET
Summary
- ULTA Beauty is the leading beauty specialty retailer in the US, with a strong market share and loyal customer base.
- The company has a diverse range of beauty products, including both high-end and drugstore brands, giving it a competitive advantage over its main competitor, Sephora.
- ULTA is trading at a historically low valuation, offering investors an attractive risk-to-reward opportunity due to its growth potential through domestic and international store expansion.
Investment Thesis
Ulta Beauty ( ULTA ) is the largest specialty beauty retailer in the United States, with a market share of 29.3%, up from 12.8% in 2012. Through continuous brand innovation, new product partnerships, store openings, and the development of its online presence, ULTA has secured a loyal audience of women and teen girls.
The company offers over 25,000 products from 600 brands in over 1,350 stores worldwide. Since 2018, ULTA has opened 281 new stores and now has over 350 shop-in-shops in Targets around the world. Ecommerce sales grew at a 27% compound annual growth rate ((CAGR)) from 2018 to 2022, as the company adapted to an omnichannel approach.
ULTA has also developed a best-in-class loyalty rewards program with over 41 million members. The company reports that approximately 95% of total Ulta Beauty sales are made by Ultimate Rewards members, which management says provides them with "incredible data and consumer insights that we are unleashing as a competitive advantage." Management has set a goal of having 50 million loyalty members by 2025. This is ambitious, but I believe it is achievable given two reasons: the increased demand for beauty products as a result of the proven mental health benefits and the opportunity for global expansion.
ULTA Best-in-Class Loyalty Program Members (ULTA Investor Relations)
ULTA's management has been doing everything right. They have grown the business, returned money to shareholders, and built a household brand name. Yet, the stock is trading at a historically low price-to-earnings (P/E) valuation. ULTA's cheap valuation is one of the main reasons I am so bullish on the stock.
The stock is currently trading at 17.4x P/E, which is almost half its 5-year average. In the last 10 years, the stock has closed at a P/E less than 18x on only 65 days. It has closed at a P/E less than 17x on only 28 days. ULTA is a screaming buy at current prices given its low valuation and leading market share in duopoly with competitor, Sephora.
ULTA has been firing on all cylinders and is expecting to open 25-30 stores this year, mid-single-digit sales/EPS growth, and $900 million of planned share buybacks, I love ULTA at its current price of $438 and would suggest looking to buy shares while the stock is under $450.
Diversified Beauty Product Market
ULTA has done a fantastic job of strengthening its product offerings through innovation and brand partnerships. The U.S. beauty products market was estimated to be worth $104 billion in 2022, and ULTA has captured a significant share of this market by offering a one-of-a-kind assortment of beauty products. ULTA's stores offer customers an infinite choice of products, a great customer experience, and the option to test products out before they buy them.
U.S. Beauty Product Market (ULTA Investor Relations)
ULTA offers a wide range of beauty products, from lotions and skin care to perfumes, cosmetics, and more. Brand partnerships with Fenty Beauty, Covergirl, MAC cosmetics, and others have given the company a competitive advantage over its competitors.
Sephora is the company's one true competitor, as they are the only two specialty beauty retailers among America's 100 largest retailers. However, Sephora only offers prestigious or high-end brands and products, appealing to the higher end of society only.
Where I believe ULTA has differentiated itself for the better is that it also sells drugstore brands that you can't get at Sephora. ULTA offers the best of both worlds, appealing to both higher- and lower-end customers. This makes them such a powerhouse in the beauty industry. I believe their acceptance of all products and trends will help them separate themselves from Sephora and ultimately make them a better investment going forward.
ULTA has also continued to add and improve its in-store service offerings, which management calls a key differentiator. They offer appointments where people can get their hair and makeup done, while Sephora only offers makeup appointments. Services is seeing steady improvements and growth, as ULTA saw service sales account for 4% of sales in Q1, up from 3%. Management has listed three key data points showing why services can help spark additional growth:
ULTA Services Data (ULTA Investor Relations)
ULTA has been great at adapting to the trends over the years, which has helped the company become a leader in the industry. They perfectly navigated through the pandemic and now have a dominant e-commerce business. Their unique and differentiated omnichannel offerings have opened up countless doors for ULTA, allowing them to reach and connect with customers both in-store and online.
Beauty and makeup have become increasingly important to individuals, with 65% of consumers believing that the beauty category is significantly connected to wellness. This has driven demand recently, and ULTA has been great at capitalizing on their wide beauty market opportunities.
Balance Sheet & Profitability
ULTA has leading industry margins and has seen consistent margin expansion in the past few years. Gross profit, operating income, and net income margins are all 200+ basis points above the 5-year average. Their net income 5-year compound annual growth rate ((CAGR)) is an impressive 16.3%, which is one reason they have seen net income/earnings per share ((EPS)) increase every year since 2009, except for 2021.
Last year, the company saw record profits and is expecting to top those numbers for new record profits this year and in the years to come. Net income margins have gone from the mid-9% range to just about 12% margins. The company's improved margins have led to ULTA having even better cash flow generation for growth and shareholder return.
ULTA Profitability Margins (Seeking Alpha)
ULTA's hard work to expand its margins resulted in record free cash flow ((FCF)) in its last fiscal year (FY), generating $1.16 billion. Cash from operations ((CFO)) was up 32% last year from the company's 5-year average, as management exercised its pricing power and made operations more efficient. Management's discipline when it comes to capital allocation has helped the stock be a winner in the past and helped keep investors loyal to the company. Shares have been reduced by over 17% in the last 5 years, while the price per share is up 86% in the same time, which means investors have gotten an average 20.6% return from ULTA in the past 5 years. ULTA still has $900 million worth of shares to repurchase based on its $2 billion share repurchase program, and analysts expect north of $1.6 billion in operating profits for the year. Smart capital allocation has been a key reason why ULTA has captured leading market share, its investment in the company's growth and success.
ULTA Capital Allocation (ULTA Investor Relations)
ULTA's business model and strategies have allowed the retailer to substantially scale its business and become the market leader. Now that the company has improved margins and cash flow generation, I hope that it will expand globally. ULTA currently only operates in the United States, but I strongly believe in the opportunity for Ulta Beauty to be a global brand. The company's balance sheet is clean and cash is flowing in. Once borrowing rates start to come down, I believe that the best strategy for ULTA is to start international expansion. Pairing global growth with domestic monetization will continue to make ULTA a winner. The time is soon for the company to take the next step up and become an international powerhouse.
Valuation and Price Targets
ULTA stock is the cheapest it has been in years, if not since it went public back in 2007. The stock currently trades at an amazingly low 17.4x price-to-earnings (P/E) ratio, a valuation that the company has seen for less than 2% of its days in the last 10 years. A 15x P/E is where most analyst consider a stock to be a "value stock", and ULTA is still growing at an above average pace and global expansion is in sight.
ULTA has a sales 5-year compound annual growth rate ((CAGR)) of 11.42% and analyst expect sales to increase between 6-8% for the next 3-5 years. They also expect bottom-line growth to continue at a quicker pace, with analyst average estimates ranging between 7-9% growth 3-5 years out. ULTA will still look to grow loyalty members and store counts, which add to the company's growth strategy.
EV/S valuation is currently 2.1x, which is below the sector median and 5-year company average. Sales have been rapidly increasing for the company as sales rose 33% in the last FY. The company's average EV/S is 2.4x, showing room for multiple expansions and an undervalued price, given its -7% drop YTD.
Using the company's current valuations and analyst estimates, I have created a price target scenario table. This tool shows how, using current valuations and estimates, I can create a price target and certain scenarios based on bullish and bearish catalysts. Meaning margin expansion, a raise in guidance, or a cut in earnings estimates can all be priced in and show the risk to reward through these tables. I have attached the results below, where we see an appealing 5.1x risk-to-reward. This means that for every dollar invested, you have the chance to make $5.1. I usually look to enter a position with a risk-to-reward ratio of over 3x. ULTA's current pullback has given investors a generational buying opportunity into the leading specialty retailer for beauty.
2024 ULTA Price Target Scenarios (Author Calculations Based on Analyst Estimates Data From Koyfin)
The table shows that the stock is currently trading at a next twelve month (NTM) 15% discount to fair value in our base case. The stock traded above $500 per share from February 2023 until May 2023, when it reported numbers below street consensus and has been hit hard since. I believe the stock is at a perfect buying opportunity, and if you are not convinced yet, I have also attached my discounted cash flow ((DCF)) statement fair value price target that gives us a longer term approach.
I calculated this by using my DCF to essentially see how much the company is worth based on all future cash flows. I calculated the company's free cash flow ((FCF)) multiple and used their current weighted average cost of capital ((WACC)) to create a sensitivity analysis for a longer-term price target to show just how cheap ULTA shares are. My long-term price target for the stock over 5+ years shows over 50% stock price appreciation based on the company's steady growth and increasing cash flow. Their return on invested capital ((ROIC)) is 5x greater than their WACC, meaning they are constantly creating value for the company.
ULTA Discounted Cash Flow Statement (Author Calculations Based on Data From ULTA's annual 10Ks)
In my opinion, ULTA is widely undervalued based on the company's growing brand reputation and international growth potential. My numbers reflect the steady growth I expect to see in the stock over time. For a bonus measure, I also included my last valuation method using my projected discounted cash flow ((DCF)) cash flow and the company's enterprise value (EV) to earnings before interest, taxes, depreciation, and amortization (EBITDA) valuation, EV/EBITDA. As you can see in the table below, it still shows that the stock is undervalued on a long-term time horizon by 50% plus. As the stock consolidates under $450, I suggest adding a position here.
ULTA EV/EBITDA Valuation PT (Author Calculations Based on Data From ULTA's 10Ks)
Risk
ULTA's number one risk is the competitive nature of its market. An analyst reported that the firm stated "more than 70,000 stores sell beauty products in the U.S. (including drugstores, mass merchandisers, department stores, e-commerce, and others). Some of these competitors, such as Walgreens ( WAL ), CVS Health (CVS), and Walmart ( WMT ), have many more stores than Ulta." Sephora, opened 45 new stores in 2021, 72 in 2022, and have goals to open 100 stores this year. ULTA will be tasked to continuously innovate within their stores services and loyalty programs to retain customers against this many different competitors in the industry. I would not be surprised if within the next two years we see Walmart, Kroger ( KR ), and even Costco ( COST ) diving deeper into the vastly growing beauty market worth hundreds of billions and estimated to grow to over half a trillion dollars by 2027. Anyways, my point here is that ULTA is going to have to innovate and renew brand partnerships in order to keep customers loyal and coming back consistently. With more options and competitors coming, management will have to pick something to continue to stand out.
The second risk to note is the reliance on physical stores and foot traffic. Although ULTA has done a great job developing the e-commerce business, a large part of the company's revenue and business still comes from people physically coming into the store. Many physical stores and shopping centers are experiencing declining traffic because of online competition and decelerating demand, which could affect the company's long-term business model. ULTA will have to find new ways to continue to get customers to come into the store and spend more time there.
The third risk I would like to note is that the company is a consumer discretionary. This means its products are not necessities, but rather wants or an accessory. Knowing this, we can assume that in tougher economic conditions, the stock may not do so well because people may pull back on their extra spending. This trend is a big theme that could affect the stock. However, the stock did great in 2022's market decline as the makeup and beauty industry was relatively resilient, showing signs that the industry may be more defensive than analysts thought. Either way, this is a catalyst that needs to be noted when considering the stock.
Conclusion
ULTA is the leading beauty specialty retailer in the United States, and I believe it is undervalued based on both short-term and long-term aspects. The company still has exponential room for growth and expansion, and it is now focusing more than ever on retention and profitability. Global expansion is the next step for the company, and it is the next phase where we can see reaccelerating growth and multiple expansion. Global growth paired with steady 4-6% same-store sales growth domestically while building 25-30 new stores, I believe the company will continue to execute and return capital to shareholders. Sales, FCF, and net income have all been trending up, and there could not be a more telling sign of a strong business and management than that.
On top of it all, the company is trading at historically low valuations due to one bad earnings report. I like to buy my stocks cheap, and I don't think you can get a higher-quality stock for a cheaper price in the market than you can for ULTA currently. I reiterate that Ulta Beauty is trading at a 15% discount to my end-of-year price target and over 50% discount to my 5-year price target. ULTA is a winner, and anyone with a sister, girlfriend, or wife knows why you should own this one. They can't get enough of it!
For further details see:
Ulta Beauty: Brand Reputation And Valuation Strongly Signal A Buy