Introduction
Ulta Beauty (NASDAQ:ULTA) is an American retailer of beauty products and cosmetics. Over the years, Ulta Beauty’s growth has slowed down and there hasn’t been much margin expansion. A weak consumer, tougher competition in advertising and promos, as well as alternative options for consumers outside of direct competition (beauty products are available through many different channels), Ulta Beauty’s have been in the dog house trading new 52-week lows. While I don’t expect these to change overnight, I think that the company’s strong market position, enhanced customer experiences, resilient traffic, and current valuation make the shares an attractive company to consider for the long term.
Company Overview
Ulta Beauty is one of the largest specialty retailers selling cosmetics, fragrance, skin care products, hair care products, and salon services. Key aspects of our business include. The company differences itself by housing 25,000 products from over 600 brands across various price points, both mass market as well as luxury and prestige.
With nearly 1400 stores across the U.S., the company’s locations are located in high-traffic locations and aims to get customers in the store by focusing on the overall shopping experience. This includes things like the Brow Bar as well as full-service hair salons in some stores. In digital, through ulta.com as well as on the mobile app, the company offsets easy pick-up options, online delivery as well as curbside pickup. The digital app and website also uses augmented reality capabilities so customers can ‘virtually try on’ various products and feel more comfortable before making a purchase.
Ulta Beauty sells branded products from other companies as well as its own private label. Given that the U.S. Beauty products market is valued at $112 billion, with $11.3 billion in total revenues, I’d estimate the company’s market share to be about 10%.
Investor Presentation
Background
Over the last ten years, Ulta Beauty has been a great stock to own. While the company’s shares have been more volatile than the overall market, they delivered a total return of 297% over the last decade compared to the S&P500’s return of just 228%. Annualizing these returns, Ulta Beauty’s CAGR of 14.8% has outperformed the S&P500’s by 220bps. However, most of Ulta Beauty’s returns over this period came prior to the pandemic. Looking at just the last five years, shares have underperformed delivering a total return of just 4.8% compared to the market’s return of 95% over the same time period.
Ulta Beauty’s growth shows up in its financials too. Over the last decade, the company has delivered strong returns on both the top and bottom line, with revenues and EBITDA growing at CAGRs of 15.4% and 16.0%, respectively. On EBITDA, the company has grown its top and bottom line at 10.8% and 11.1%, respectively (source: S&P Capital IQ). Two conclusions can be drawn from this. Firstly, with the five year CAGRs lower than the ten year CAGRs, Ulta Beauty’s growth rates have slowed down. Secondly, as EBITDA growth is roughly in line with revenue growth, as opposed to outpacing revenue growth, the company hasn’t been able to deliver much margin expansion over time.
Author, based on data from S&P Capital IQ
Recent Results and Outlook
When looking at the recent Q1’24 results, Ulta Beauty reported revenues of $2.73 billion, which was up 3.5% compared to last year’s Q1, in line with consensus estimates. EPS came in at $6.47, beating analyst estimates by 19 cents.
Company Filings
Overall, this was an okay quarter for Ulta Beauty, as evidenced by a small 3% move the day after the results were released. On the earnings call, management noted that single-digit revenue growth was expected given the strong performance they lapped last year. As such, on a comparative basis, comparable sales were up only 1.6% versus 9.3% from Q1’22 to Q1’23.
In my view, one of the key highlights this quarter were that the company opened 12 stores, seven more than last year. So far, management says that their performance is exceeding expectations and employee retention across existing stores remains very strong, so labor challenges seemed to have largely gone away.
Another important note was that the company shifted the remaining few distributions centers to the new ERP system so that now “all of the company’s primary distribution centers are operating on the same platform”. ERP migration is also starting up in stores and the company has already transitioned 30% of them.
Finally, other key developments include a partnership with DoorDash and the brand launches of Sol de Janeiro, Charlotte Tilbury, Serena Williams, and Kylie Jenner Fragrance. The latter two of those were exclusive deals, so the company is really making the most of these high-profile partnerships to generate excitement and drive sales. By offering products tied to well-known celebrities, the company boosts its visibility and creates a sense of urgency among customers, which helps them stand out in a crowded market and can lead to significant revenue growth.
In terms of the negatives, the story really here is on the margins. During the quarter, gross profit fell by 80bps with SG&A as a percentage of revenue increasing by 120bps. Operating income declined 210bps and net income declined 170bps.
Company Filings
This isn’t something you want to see. On the earnings call, management blamed higher promotions and ongoing problems with shrinks. In my view, I attribute this to a more difficult operating environment, one where competitors are spending aggressively to win business. Long-term, I don’t see much margin upside with EBITDA margins likely steady around the 17% range.
Because of the weakness this quarter, management decided to lower guidance. This was unusual as just one quarter through 2024 was enough to shake confidence in guidance from three months ago. Revised guidance is now for revenues of $11.5 billion to $11.6 billion (from between $11.7 billion and $11.8 billion prior), EPS was also lowered from between $26.20 and $27.00 per share to between $25.20 and $26.00 per share.
In my view, I think the guidance at this point is likely on the more conservative end now. Why? It’s unlikely that management would revise guidance for a second time lower between now and the end of the year. With shares having sold off since the quarter and trading at 52-week lows now, there could be an opportunity here, as I’ll discuss in the valuation section.
Risks
But first, let’s discuss risks. Ulta Beauty is a consumer discretionary company, meaning it’s highly sensitive to swings in how the consumer’s economic position changes. Unlike true luxury brands that tend to be more resilient, Ulta Beauty’s customers include those from all price points, so it does have significant exposure. That said, with a strong loyalty program of over 40 million people as well as e-commerce making up a decent 21% of sales, the company seems to insulate some of this risk versus its peers.
Other risks relate to competition. One of the reasons why margins haven’t been improving year to year is that the beauty industry is highly competitive. As a retailer, the company still maintains very good margins, but fierce competition from retailers like Sephora as well as online indirect competition like Amazon are constantly fighting for attention with the top global beauty brands. Given this, it’ll be important in my view to continue to monitor partnership wins as well as how competitors ramp up and position to steel Ulta Beauty’s lunch.
The defensibility of Ulta Beauty’s moat is that it already has several brick and mortar stores. However, having a huge physical store presence across the U.S. has meant that growth in store count is likely to slow from here. With physical stores in decline, how Ulta Beauty (and the rest of the industry) pivots to this trend will be key going forward. According to a few industry reports, mall traffic in stores that remain haven’t actually slowed down; they’re up. One such report found that foot traffic in top-tier malls was up by 12% in 2022 compared to 2019, while traffic in lower-tier malls was up 10%. The interplay between a declining number of stores with foot traffic in existing ones up should be watched, particularly if one or both of those trends start to reverse.
Valuation and Wrap Up
Based on the 30 sell side analysts who cover the stock, Ulta Beauty currently has 14 ‘buy’ ratings, 15 ‘hold’ ratings, and 1 ‘sell’ rating. From the current price, analysts are forecasting about 29.1% upside to the average target price of $469.15 one year out.
Seeking Alpha
When looking at the historical valuation range compared to the current multiple, Ulta Beauty is trading at a wide discount at 8.9x EV/EBITDA. The last time shares were this cheap was during the March 2020 COVID-19 sell off. Is this discount to the historical ten-year average warranted? In my view, a discount is warranted but not this steep. For a company trading 14.4x P/E and 14.1x on a forward basis, I think the valuation looks compelling here. Based on analyst estimates, the company should be able to grow its earnings at a 9% CAGR into 2027 so a mid-teens multiple seems quite cheap in my view (source: S&P Capital IQ).
Altogether, Ulta Beauty is a business under a cloud. Based on largely cautious outlooks by other analysts and the rest of the market, the company is trading at a 52-week low. Some of this makes sense: margin pressures, increased competition, and lowered guidance have contributed to the current valuation. However, the company still has a strong market position, a loyal customer base, and solid growth in store openings (for now) and partnerships that suggest that there are opportunities for rebound and long-term value creation. With its current valuation reflecting significant discounts compared to historical averages, and considering the potential for recovery and growth in earnings, investors might find Ulta Beauty an attractive proposition at current levels. For these reasons, I rate shares of Ulta Beauty as a ‘buy’ today.
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