Why Ulta Beauty Is Compelling Over Amazon

Ulta Beauty (ULTA) rebounded quickly from near yearly lows in March but in the last month, the stock’s upward momentum is on pause. At a 24 times P/E that matches the pace of earnings growth rate of around 17 times earnings next year, investors must ask if it is time to take profits or to continue holding on the stock.

A number of bearish, analysts downgrades in late last year sent ULTA stock on a downward path, but management proved to skeptical investors that the company held more business value. Ulta’s track record in the last five years shows consistent sales and earnings growth. Comparable sales stumbled only once, in 2017, albeit due to an unusually strong 2016 year. As the bar chart shows, below, comp. sales fell from 15.8 percent in 2016 to 11.8 percent in 2017. Still, store net sales grew as store openings increased:

Source: Ulta Beauty

Source: Ulta Beauty

Ulta is in the early innings of capturing its total addressable market. With a wide array of products across multiple beauty markets, Ulta has just 4 percent of the U.S. beauty market and 6 percent of the beauty products market. Its share of the services market is below 1 percent. Ulta clearly has plenty of growth ahead and so far, management is proving that it will capture more of the beauty market this year.

Ulta’s Differentiating Offering

Ulta’s business model hinges on targeting the “Beauty Enthusiast,” which are those who are passionate about beauty and who offer the best experience in shopping, whether it is online or in-store. Beauty enthusiasts make up 77 percent of the revenue, compared to just 23 percent of non-beauty enthusiasts.

The company builds upon its loyal customer base through a membership program. As of May 2018, Ulta had 28.6 million active members, with which it uses targeted CRM campaigns to get them buying products. The Diamond tier launch, for example, awards those who spend more than $1,200 annually. The company has plenty of room in building its customer base. Ulta listed loyalty member acquisition, boosting spend in more categories, and beating out competitors, as its three main goals.


AMZN data by YCharts

Amazon.com (AMZN) is the most dangerous but beatable competitor. The e-tailer may make most of its profits from AWS but on the retail front, it operates at low margin due to shipping costs and a lack of specialization. Conversely, Ulta has a motivated and passionate sales force that is winning its share of online AND offline sales.

Source: Ulta Beauty

In the last year, guest customers grew, with sales offline outpacing its online sales by 2:1. But with only 10 percent of the guests being loyalty members, Ulta has plenty of work ahead to convert them.

Catalysts for Growth

Ulta drives its business by offering brand product “newness.” Below are the brands that keep its customers coming back and spending:

Source: Ulta Beauty

New store openings are a second catalyst for growth. Ulta’s new stores have a payback period of just two years. Spending just $1.6 million for a 10,000 square foot store will bring in $4.5 million within five years:

New Store Model

Ulta projects opening 1,174 stores by end of 2018. This translates to $5.3 billion in additional revenue after five years.

To ward off the Amazon effect, Ulta’s deep dive into e-commerce creates another opportunity for growing the business. In 2017, e-commerce grew 56 percent and accounted for one-tenth of sales.

Source: Ulta Beauty

Ulta is not an Amazon.com of cosmetics but the five-fold sales growth in the last five years is impressive. Management said it will improve its fulfilment capabilities by fulfilling 95 percent of orders within 3 days.

Outlook for FY 2018 and Takeaway

On top of spending $625 million buying back shares, Ulta will increase shareholder value by delivering higher sales (low-teens), grow its e-commerce business by around 40 percent, and reinvest in its business using its “earnings” made through tax reform. At a $10.75 EPS for this year, the 23x forward P/E is substantially lower than the 85x AMZN stockholders are paying. Needless to say, ULTA shareholders should keep holding the stock. DIYers (do-it-yourselfers) who bought the stock when it was mentioned late last year will enjoy more capital gains ahead.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ULTA over 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.

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