Ulta Beauty: A Truly Beautiful Story For Investors

Summary

• The company's financial performance was solid during the quarter, driven by new product management.
• Skincare and fragrance were particularly strong, in our view.
• With shares reacting well to the earnings print, we see another 15% upside in the near term.

About the Company

Ulta Beauty, Inc (ULTA) focuses on the beauty retailer business, offering fragrance, cosmetics, skin, hair care products and salon services. Its products are at 20,000+ across 500 locations. Among various products are face powder, concealer, face primer, blush, bronzer, shampoos, conditioners, hair styling products, hair styling tools and perfumes, to name just a few. The company has a full-service salon in most stores featuring skin and hair services. ULTA operates only in the United States at present.

Valuation

Our 2020 P/E multiple of ~23x continues to be justified, as we consider 1) cost optimization initiatives, 2) future promotions; and 3) capex outlook. When we apply it to our 2020 EPS estimate of $13.13, we get a target price of $298.

Continued Attractive Story

Solid market share gains: It is our understanding that over the last several quarters, ULTA achieved market share gains across 300, possibly 350 products. While we do not anticipate to see much revenue traction in 3Q or 4Q (it is very difficult to quantify at this point), we believe that in 2020 the company should expect anywhere between 30 bps and 55 bps in revenue growth acceleration.

Financial performance solid during the quarter: With total sales growing 7.9% Y/Y and comp store sales growing 3.2% Y/Y, we saw an expansion of 40 bps for the gross margin, while the EPS rose 3.2% Y/Y.

Skincare trends on the move: In 2019, ULTA added 30+ new skincare brands to its products base, while upping the marketing campaigns to focus on the prestige factor, in addition to creating extra space in its stores to emphasizes the new additions. In fact, it is skincare where ULTA is seeing the aforementioned market share gains.

Fragrance benefits from new brands: The high-single digit revenue growth was not surprising given the launch of exclusive fragrances from Ariana Grande, Jennifer Lopez, and KKW Fragrance, as well as the newness from some luxury brands, such as Versace and Dolce & Gabbana. We expect similar top line growth in 2020.

Not worried about makeup: While much has been said in the analyst community about the softness in the makeup segment, we maintain that this business is cyclical and that we should see a rebound toward the end of 2020. As management correctly admits: "Makeup looks and trends are constantly evolving, driven by industry innovation, fashion, and pop culture." We expect the new products to come along and deliver new opportunities for the company.

Strong growth in brand loyalty: As of 3Q, there were 33.9 million active members in the ultimate rewards loyalty program, representing 11% Y/Y growth. Given that sales from loyalty members are at 95%+ of total revenues, having this kind of traction trending above total sales growth (which was, as you may recall, ~8%) is a signal to continuous strength of member engagement. In that respect, the company does a very solid job not only in bringing on board new members, but also in retaining legacy (first- and second-year) members. Much remains to be seen when these members mature toward 5-year membership in 2022-23, but we will cross that bridge when we get there.

Finally, real estate activity is on a strong footing: We note that the new and remodeled stores are on a decline from a year/year perspective, about 10-12 fewer. We see this as a saturation effect tied to the new store productivity and also mindful of the overall cost effectiveness. Therefore, it is the emphasis of bottom line management over store quantity that should be guiding ULTA forward.

Risks to Our Thesis

We see the following business risks for ULTA:

1. Macro risks are the biggest concern to any luxury retailer, since high-end goods are usually the first ones to be curtailed once disposable income goes down.
2. Fake brand risks, since there is a rising trend of “faux” jewelry and handbags, which could decrease ULTA's sales.
3. Real estate costs keep rising around the world and could pose a substantial challenge to the company’s bottom line.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.