Ulta Beauty is an American beauty retailer offering cosmetics, fragrance, skin care products, hair care products, and salon services. It operates both online and through physical stores, providing a wide range of products from various well known and emerging brands, including its own private label. The company aims to provide a one-stop-shop experience for all beauty and personal care needs across diverse price ranges.
Ulta Beauty’s orgins date back to its 1990 founding by Richard E. George and Terry Hanson. The company was originally named Ulta3 and started with the idea of offering a wide range of beauty products under one roof. This approach was quite innovative at that time, as it broke away from the traditional department store model. From 1999 to 2006, Lyn Kirby took over as CEO. Under her leadership Ulta expanded significantly introducing salon services and launching a private label of beauty products. In 2007, Ulta went public on the NASDAQ under the ticker symbol ULTA with 207 stores across 26 states. The IPO provided Ulta with capital for continued to growth both in terms of physical stores and its online presence. As of their quarterly period ended July, 2023, Ulta Beauty operates 1362 stores across all 50 states. They are the largest beauty retailer in the United States, offering more than 25,000 products from more than 600 well-established and emerging beauty brands and employee aproximatley 53,000 people.
Operations
Ulta Beauty derives its revenues from the sale of cosmetics, fragrance, skin care products, hair care products, salon services and more. Revenue segments have been consistent over the past decade consisting of 42% cosmetics, 21% haircare products and styling tools, 17% skincare, 14% fragrance and bath, and 3% services that include their salons and expanding nail and skin services. Another 3% of revenues comes from accessories and other which consists of the private label and cobranded credit card programs, royalties derived from the Target partnership, and deferred revenue related to the loyalty program and gift card breakage.
Ulta seeks to provide a one-of-a-kind assortment of merchandise for its guests by offering a massive selection of products and brands across varying price points. These brands are generally categorized into Mass, Masstige, and Prestige. Mass is considered your widely available and affordable, products designed to appeal to a broad audience and often produced in large quantities. Examples include Covergirl, L’Oreal, Dove, and Neutrogena. Masstige is your premium, higher quality products that may be available in both mass market retail outlets and more upscale stores. Examples include Morphe, Colourpop, Juvia’s Place, and NYX Professional Makeup. Prestige is your high end, premium priced products typically available in high end department stores or specialty stores. Examples include MAC, Dior, Chanel, Olaplex, and Fenty Beauty by Rihanna. Ulta does not give a revenue breakdown for these different categories, but I will note that in times of economic drawbacks, customers tend to trade down to the lower categories. This can result in lower margins and income as customers opt away from Masstige and Prestige products that afford premium margins.
Ulta sources the majority of merchandise from several brand partners, who source or manufacture their products from plants and countries around the world. The top ten brand partners represented 56% and 54% of total net sales in fiscal 2022 and fiscal 2021 respectively. (Fiscal periods run from the end of January to the next) L’Oréal and Estée Lauder Companies were among these top sellers but Ulta’s management does not give a full list. Fortunately, there are several industry and consumer lists that give us insights into top selling beauty and cosmetics products by company, brand, and product line. Click here, here, here, here, and here. Ulta’s success is dependent on maintaining good relationships with brand partners. Although the company does not engage in long-term supply agreements with brand partners, Ulta believes it provides a significant distribution channel for growth and brand enhancement allowing for a favorable market relationship. In order to do business with Ulta, brand partners or vendors are held to certain vendor standards. These include ethical, legal, social, environmental, and workplace standards. Ulta’s brand partners source and manufacture their products around the world but I will note that many have a heavy manufacturing presence in China, especially L’Oreal and Estee Lauder. Vendor standards aside, I do see this as a potential risk for Ulta and many of its brand partners with increased geopolitical tensions related to China.
The Ulta Beauty Collection is Ulta’s private label products. The collection is a growing part of Ulta’s sales, representing 10% in fiscal 2022. Some of these products are permanent while others are more exclusive in their nature. The majority of our Ulta Beauty branded products are manufactured through third-party vendors using foreign factories.
Brick and mortar stores are still Ulta’s bread-and-butter with respect to retail channels. The typical brick and mortar store is 10,000 square feet of which 950 square feet is a dedicated salon area. The company typically locates these stores in convenient, high-traffic locations such as power strip centers. The average Ulta store is open seven days and employees approximately 28 full and part-time associates, including approximately four to eight prestige consultants and five to ten licensed salon professionals. Each store is managed by a general manager who is incentivized by performance bonuses. Ulta does have a handful of smaller 5,000 square foot stores to serve “lighter demographic” areas. A new Ulta store typically requires $1.7 million investment to outfit and open in 2023, up from $1.4 million in 2021. Ulta believes it can open between 1,500 and 1,700 stores in the United States market. They have opened approximately 35 new stores per year on average over the past five years. I expect this will slow due to higher costs and more cautious business expansion. At the current store count of 1,362 stores, Ulta does have limited growth into the future assuming no international expansion, which is a long term goal for the company. Ulta has consistently grown comparable store sales year over year with the exception of the initial Covid shock of 2020. In addition to its brick and mortar stores, Ulta operates an omnichannel and ecommerce digital platform that they are constantly growing and improving the efficiency of. Ecommerce sales grew by a CAGR of 27% between 2018-2022.
In 2021, Ulta announced a partnership with Target for a store within a store concept where Ulta will have a 1000 square foot of dedicated space for highly-curated, prestige beauty products. As of their March 2023 10K, Ulta is in over 355 select Target locations with a total planned expansion to around 800 in the coming years. This partnership allows Ulta to increase sales, reach new customers, compete with other beauty retailers, and increase convenience for customers. Ulta also benefits from sharing in Target’s reward program and greater ecommerce presence.
On the logistics front, Ulta operates four distribution and two fast fulfillment centers that support both physical stores and their e-commerce channel. 115 Ulta stores are also responsible for e-commerce fulfillment as part of a ship-from-store program. Products are delivered to stores using a broad network of contract and local pool carriers. This year Ulta is introducing a market fulfillment center, which will focus on their most productive products enabling improved service and responsiveness to physical store and ecommerce channels.
Ulta’s business model is similar to most retailers with respect to seasonality. The company realizes a significant portion of revenues in the fourth quarter of the fiscal year around the holidays, similar to other retailers.
Strategy
Ulta has a multi-pillar strategy designed to expand market leadership and drive longer-term profitable growth. When it comes to their customer base, Ulta puts a strong focus and priority towards beauty enthusiasts whose emotional connection to the beauty world is resilient in softer economic times. To engage beauty enthusiast, Ulta constantly focuses on maximizing growth in core categories, driving growth of cross-category strategic platforms, differentiating their assortment through exclusive brands and product, and increasing profitability through operational optimization.
Ulta plans to further grow their physical stores as well as their omnichannel and digital experiences. Some of Ulta’s success over the past five years can be accredited to their Ultimate Regards loyalty program which has grown to 41.7 million people or around 6% per year on average. According to their 2023 Investor’s Presentation, 95% of total sales come from loyalty members. Ulta leverages the vast data of their loyalty program to increase guest engagement and gain consumer insights providing a competitive advantage. Other major strategy plans include building efficient and scalable operations to optimize their business model, improve their environmental and social impact, and nurturing a strong culture that attracts and retains talent.
The Beauty Industry
The beauty and cosmetics industry in 2023 was worth approximately $100 billion in the United States and $460 billion worldwide. By 2027 the industry is projected to be worth near $580 billion worldwide which is a 5.9% CAGR. Growth in the United States is expected to be similar although will vary among categories. For example, wellness and beauty are expected to grow faster at 10% CAGR vs cosmetics at around 2.6% CAGR. Figures can vary depending on industry insights reports and the categories that go into these projections, but growth rates are similar across what I have researched. Ulta has an estimated 9% share of the industry. The largest markets for beauty products are the United States and Asia.
The beauty and cosmetics industry has increasingly low barriers to entry which makes it an extremely fragmented and competitive environment. With more companies entering the space there will likely be an increase in mergers and acquisitions. Over the past decade there has been vendor consolidation within the beauty products industry, with French and U.S. based companies becoming the dominant players. Ulta Beauty, Sephora, Bath & Body Works, MAC Cosmetics, Sally Beauty are all major beauty and cosmetics retailers that compete with one another in the United states in addition to other specialty stores and discount retailers including Nordstrom, Macy’s, Target, Walmart, CVS, Walgreens, Kohls, many more. While researching some of the top selling products in the industry I have found that many are available on Amazon. A Morgan Stanley Analysis on Ulta from 2019 noted that few of Ulta’s top selling products were available at Amazon or Walmart. This no longer seems to be the case, which may indicate a weakening business model for Ulta and other beauty retailers. With this development, I expect that a strong loyalty program and exclusive deals will be increasingly important to the business model which Ulta does have.
When it comes to shopping for beauty products, there is a consumer preference towards shopping in store vs. online. The ability to physically explore products, try out samples, and seek advice from an in-store beauty advisor remains important to many beauty and cosmetics customers. Although physical shopping is preferred, e-commerce is a growing sales channel across the industry, growing approximately 20% annually over the past eight years and accelerated by the pandemic. Ulta does not provide much detail on their e-commerce segment. Although online shopping can be a great place to compare and learn about new products and watch tutorials, most customers use it to order or refill products they are already familiar with.
The typical customer for Ulta and the greater part of the industry is the beauty enthusiast. These people are passionate about beauty, cosmetics, skincare, and related products and view beauty as more than just a routine, but a significant part of their lifestyle. They prefer the in-store experience but appreciate the online option as a way to access special deals and restock with their regular purchases. Many of Ulta's customers are active on social media platforms and follow beauty influencers who often influence their product choices. The industry caters to all ages but the most active of their customer base are those between the ages of 25 and 45.
The beauty industry is subject to various regulations and standards to ensure product safety, quality, and consumer protection. Regulatory bodies, such as the U.S. Food and Drug Administration (FDA) and the European Union's Cosmetic Products Regulation, oversee the safety of cosmetic products. They require manufacturers to ensure that their products are safe for consumer use and that ingredients meet safety standards. Certain ingredients may be restricted or banned due to safety concerns. There are many other regulations with respect to labeling and packaging, advertising, fragrance, sunscreen, and increasingly in areas of CBD infused products and environmental considerations such as microplastics and endocrine disrupters. Other organizations that handle regulations effecting Ulta include the Consumer Protection Safety Commission (CPSC) and the U.S. Federal Trade Commission (FTC).
Revenues in the beauty industry are driven primarily by trends in consumer and discretionary spending. As discretionary spending rises or falls, the industry experiences similar patterns in their revenues. Some spending in the industry can be sticky as there are many customers who view their beauty and cosmetic purchases as essential. There is also a routine nature to some categories including wellness and skin care that result in reoccurring transactions. CEO David Kimbell states in Ulta’s 2023 second quarter earnings call, “Beauty is not immune to macroeconomic challenges, but has historically been more resilient compared to other discretionary categories due to its deep emotional connection with consumers.” Although this assessment appear true in historical context, I don’t agree with investment media’s current narrative that the industry is “recession proof”. I am skeptical of this perception and feel it is consumer spending on the back of lingering Covid 19 stimulus and the (arguably poor) spending habits of Ulta’s key demographics play a role in the industry’s strength as of late.
Trends that are gaining momentum or emerging in the beauty and cosmetics industry include an increased interest in wellness products, increased customer focus on the efficacy of brands especially among the Gen Z demographic, rising awareness of product side effects such as parabens, and growth in the Middle East, Asian Pacific, and South American regions. As mentioned, E-commerce is a growing sales channel across the industry and will likely continue to grow as technology further enhances the customer’s digital experience to discover new products. Social media will continue to be a marketing force in the industry.
Acquisitions
In 2018, Ulta acquired two technology companies in a strategic push to grow its digital channels. The first of these acquisitions was QM Scientific, an AI retail data mining platform that leverages data from PoS, loyalty systems, IoT devices, and more to understand consumer behaviors and insights. The other acquisition was GlamST, a technology company specializing in AR (augmented reality) and AI for the beauty industry that is now integrated into Ulta’s e-commerce platform allowing customers to virtually try on makeup and test products online.
Little information is known on the costs related to these acquisitions. The cashflow statement for the 2018 fiscal year shows that approximately $15.7 million in cash was used in the acquisition. The acquisition related to AR capabilities does appear to have been made in response to Sephora’s partnership with ModiFace. Ulta’s AR capabilities experienced a significant increase in usage during the pandemic and reviews of this feature show that it is effective and well-liked by customers.
Competitive Advantages
Ulta Beauty benefits from a couple of key competitive advantages. They are the largest beauty retailer in the United States and one of the largest in the world, which enables the company to benefit from a degree of economies of scale in areas of inventory purchases, logistics, and marketing. Ulta’s expansive product mix allows them to appeal to a large, diverse range of customers and capture industry shifts in consumer preferences. Their distribution channel includes a growing nationwide store footprint and increasing presence in select Target stores. The Target partnership allows Ulta to leverage Target’s vast retail infrastructure, share in marketing and resource costs, and expand their reach into a higher traffic retailer. Ulta’s strong distribution network also gives them the ability to secure exclusive product launches such as unique brand or celebrity collaborations and makes them a high priority among vendors.
Ulta has uniquely positioned its stores as a one-stop-shop not just for beauty products but also in areas of salon services including hair, skin, and brows in some locations. Their omnichannel and ecommerce experience is fun and modern allowing customers to try products both physically and digitally, and speak to beauty consultants.
The last competitive advantage I’ll touch on is Ulta’s loyalty program. Ulta has a very strong Loyalty program that has grown to over 40.2 million customers of which more than 95% of total sales comes from members. With this large amount of primary data Ulta can provide personalized experiences, recommendations, and promotions through their Customer Relationship Management (CRM) platform as well as leverage other customer insights in areas of product mix and store openings. The loyalty program allows customers to earn points to use towards future offers. In May of 2022, Ulta launched UB Media, a suite of media capabilities that leverages Ulta’s vast CRM and loyalty program customer data. UB Media will be accessible to brand partners and aims to personalize guest engagement and drive the acquisition of new guests. Although this initiative is new, its capabilities are expected to be beneficial and strengthen Ulta’s brand and vendor partnerships.
Capital Allocation
Ulta uses much of its free cash flow to repurchase its own stock and make additional investments to the company. In 2023 Ulta repurchased $900 million in company stock or 2.192 million shares. Under the current share repurchase program, Ulta has the ability to repurchase up to $2 billion of the company’s common stock. I estimate that Ulta has around $500 million left for repurchases under this current program. In reviewing Ulta’s historical share repurchase patterns and price charts, I feel that Ulta has at times repurchased shares at elevated prices. Ulta does not pay a dividend at this time.
Management and Board
Ulta Beauty’s leadership team consists of ten key members, many of whom have worked their way up the corporate latter serving in various senior roles in Ulta or other companies. The company’s CEO is Dave Kimbell, who has held the position since 2021 when Mary Dillion handed over the reins. Dave Kimbell has been with Ulta since 2014 and served as President prior to his CEO role. From 1995 to 2001 Dave held a number of brand management roles in the Beauty Division of The Procter and Gamble Company.
Other members of the leadership team include CFO Scott Settersten who served at Price Waterhouse Cooper as an accountant prior to joining Ulta in 2005. President and COO Kecia Steelman, who has been with the company since 2014 serving as Chief of Store Operations and Senior Vice President of Store Operations. Chief Merchandising Officer Monica Arnaudo, Chief Supply Chain Officer Amiee Bayer-Thomas, Chief Digital Officer Prama Bhatt, General Counsel and Chief Risk & Compliance Officer Jodi Caro, Chief Marketing Officer Michelle Crossman-Matos, Chief Technology & Information Officer Mike Maresca, and Chief Human Resources Officer Anita Ryan. For more information on management click the link.
Ulta’s Board of Directors consists of eleven members. The Chair of the Board is Lorna Nagler who has served in various senior management positions across several different retailers. CEO Dave Kimbell also sits on the Board. Other Board member include Michelle Collins, Kelly Garcia, Catherine Halligan, Patricia Little, Michael MacDonald, George Mrkonic, Heidi Petz, Gisel Ruiz, and Michael Smith. In reviewing the experience and backgrounds of the Board of Director I’ll note that of them have experience cross areas of retail, e-commerce, supply chain, finance, marketing, technology and more.
CEOs and NEOs (Named Executive Officers) are well incentivized in terms of the compensation plans set by the compensation committee. This includes a base salary that generally makes up between 13% and 24% of an executive pay with the rest being performance-based compensation consisting of a long term incentive plan and annual incentive targets. Long term incentive plans consist of performance based restrictive stock, stock options, and restricted stock units. The Board of Directors is compensated through fees earned of paid in cash and stock awards. For more information on executive compensation and overviews of the leadership team check out Ulta’s From DEF 14A.
Between executive members of the leadership team and the Board of Directors, insiders hold a small .34% percent of shares outstanding. Although this seems small it is still a relatively substantial amount with respect to personal wealth equating to an upper six figure to seven figure holding for many insiders. The largest shareholders of Ulta stock include The Vanguard Group at 11.7% and BlackRock Inc. at 8.1% as of April 2023.
Risks
Like any business, Ulta Beauty and its business model face a variety of potential risks. Some operational risks relevant to Ulta include supply chain disruptions, third party logistics, inflationary pressures, inventory shrink, disruptions to ecommerce platform, vendor relationships, execution of strategic business plans, and loss of certain senior members of management. As a retailer that heavily relies on third party vendors for inventory, Ulta would likely be subject to any operational disruptions experienced by those vendors. As mentioned in prior sections, Ulta’s top ten brand partners represent over 50% of total net sales. A disruption to the operations of companies like L’Oreal and Estee Lauder would negatively affect Ulta. Inventory shrink has been a growing concern for the company. Ulta has taken action to combat this through increased staffing levels, lockable cabinets, and partnering with local law enforcement with other retailers. Inventory shrink is expected to remain an issue moving forward with the additional costs putting downward pressure on margins.
On an economic and market level Ulta faces other risks including increased competition, declines in consumer spending, changes in customer traffic in areas where Ulta stores are located, lingering Covid 19 concerns, and ESG initiatives. Ulta’s balance sheet is quite strong with the company carrying little to no debt. The majority of the company’s liabilities consist of long-term lease obligations. With that said, declines in discretionary spending due to inflationary pressures, recessionary concerns, levels of employment, interest rates, tax rates, and the availability of consumer credit would likely have a negative impact on Ulta’s profitability. October 2023 marks the return of college loan repayment which will likely affect the spending patterns of Ulta’s core demographic groups.
Further notable risks Ulta may face include changes in industry regulation and local laws related to the sale, ingredients, and manufacturing of certain cosmetic and beauty products. Actions by the FDA, FTC, CPSC, and other regulatory bodies should be taken into consideration. Although Ulta is well positioned to respond to changes in consumer preferences, rapid moves may negatively affect the company. Other risks include cybersecurity where a breach of Ulta’s vast consumer loyalty and CRM system may damage reputation and result in heavy liabilities. Litigation related to intellectual property infringement and products side effects. Public relations and marketing related risks where negative commentary on social media regarding Ulta or products may have an immediate and negative impact on the company regardless of accuracy.
Historical Performance
Over the past decade, Ulta has consistently grown their revenues with a CAGR of approximately 16% with store expansion and growth of comparable store sales being the largest contributors. Revenues have well outpaced competitors and the company has gained overall market share. Earning per share have likewise grown with a CAGR of 25.3% over the same time period. Return on assets and return on equity have steadily grown over the past decade. Margins have been steady with slight improvements over the decade, especially on the back of Covid. Ulta has a strong return on invested capital coming in around 32% on average. My own calculations of ROIC came in slightly lower.
Ulta does not pay a dividend but seeks to return capital to shareholders via regular share repurchases. Over the past decade, Ulta has repurchased around 20% of its common stock. The company has consistently grown free cash flow with a 31% CAGR over the decade. I expect this will normalize in the coming years but continue to steadily grow in the lower double digits. Ulta’s balance sheet is quite strong with no debt and significant cash flows to cover liabilities. With that said, I do intend to monitor a few of Ulta’s balance sheet lines including accrued payroll and benefits which have increased significantly in the past few years.
2023 has remained a strong year for Ulta with the company actually raising guidance in their second quarter earnings report. As of the second quarter 2023 10Q filing, Ulta has achieved record revenues led by eight new store openings and continued growth in comparable store sales. The increase in comparable store sales can be credited a 10.1% increase in transactions and a 1.4% decrease in average ticket value. SG&A expenses have increased a significant 17.1% compared to the same period in 2022. Management sites new store openings, higher corporate overhead due to strategic investments, higher store payroll and benefits, and higher marketing expenses, as the main culprit for this increase. I intend to monitor expenses in future reports for further disproportionate increases compared to store growth. In the near term, Ulta’s business has been resilient to the slowing economy and has not seen much trade down by customers to lower cost products. As we head into the rest of 2023 it will be interesting to see Ulta’s results in the face of student loan repayments, continued battles with inventory shrink, and other macro-economic conditions.
Valuation
Using a discounted cashflow model and a reverse discounted cashflow model I estimated a fair value for Ulta of approximately $450. This is using what I believe to be conservative inputs including a 8% variable growth rate the declines down to 4%, a discount rate of 9%, operating margins of 13.5% and ROIC of 25%. I believe a bullish take could easily put Ulta near between $500 and $530 per share. At my fair value estimate of $450 and Ulta’s current trading price near $379, it would have a margin of safety of 16%. With respect to valuation ratios, Ulta currently trades below its historical price to earnings. Price to book is trades within its historical range, and price to sales is below its historical range. Price to free cashflow also comes in below its historical levels.
Final Thoughts
Ulta Beauty is a clear leader in the beauty and cosmetic retail industry with its massive range of products that can easily capture changes in customer preferences. They have an immensely loyal customer base and strong loyalty program whose data is consistently used to identify market trends, engage customers, increase sales, and further build brand loyalty. Ulta’s retail and data capabilities make them desired partner among beauty and cosmetic vendors. The company has favorable expectations of growth into the future with the addition of more brick-and-mortar locations, further expansion into Target, and the potential for international expansion. Ulta does face headwinds in the form of growing SG&A expenses, inventory shrink, financially struggling customers, and competition from ecommerce. Many of these issues are temporary and I believe Ulta is in a relatively strong position to adapt to the market. Taking a look at valuation, Ulta is undervalued compared to historical levels, but it does fall short for me in terms of a minimum margin of safety. I would like to see Ulta trading closer to $350 before considering a position. I intend to monitor Ulta’s performance and progress moving forward, and I am quite eager to see how the company fairs over the next year with this current economy.
Thanks for reading and best of luck on your own investment endeavors.