Ulta Is More Than Just A Beauty Retailer

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 |  About: Ulta Salon, Cosmetics & Fragrance, Inc. (ULTA), Includes: FDIS, FXD, PEZ, PSCD, RCD, VCR, XLY
by: Darius Samz

The retail industry as a whole has not been great. Even though some stores have had good results retail has been suffering. Since Ulta Salon (NASDAQ:ULTA) is thriving in the tough environment they should do even better as the economy continues to improve. Over the past 3 years Ulta has been able to produce 22% annual revenue growth and 63% net income growth with over twice the industry average for ROE and margins and no debt. Furthermore, due to missing earnings and revenue estimates last quarter the price is greatly reduced but not for long as this is only short-term weakness.

Risk

Ulta has very little downside risk since the increase in the stock price is matched by its rise in revenue. Right now the stock is volatile due to analyst and investor recognition of its potential. This was obvious in the sell-off after the poor earnings report last quarter and the only miss in five years. The high growth company is under unrealistic pressure to continue its growth but now is in a better position for profit. While I believe long term they will continue to grow, the current expenses and economic backdrop will provide volatile earnings.

Opportunity

The opportunity for appreciation is largely due to its relative newness and its aggressive but achievable growth plan. Ulta plans to change the way beauty retailers are seen and are creating loyal customers both online and in-store. The choice of Mary Dillon as CEO is smart as her experience in other consumer products will help drive Ulta forward. She has always used consumers' insights to create strategies that have propelled gains in other companies she has run such as McDonald's and Quaker Foods. Most of her background covered marketing and in the field of beauty products marketing is everything.

Time frame

As the marketing strategy develops earnings will continue to rise so the time frame for profit is a multi-year play. There will be plenty of short-term moves (like the recent +20% then -20% move) but the full potential of this stock will come from holding and adding to your positions over many years. This company is in its infancy for gathering crowd appeal that will only grow. I also think they will expand into other markets as the brand grows. International growth is a large factor in growing sales and brand recognition; Ulta has yet to tap that resource.

Future Plans

Ulta's next few years are governed by its 5-point plan in which it targets 15-20% annual square footage growth and 4-6% annual comparable store sales growth.

5-Point Plan

1. Accelerate Pace of New Store Expansion - 1,200 Store Plan in the United States

2. Continue to Expand Offering with New Products, Services, and Brands

3. Enhance Successful Loyalty Program

4. Broaden Marketing Reach

5. Increase Focus on Digital Strategy

New Store Expansion

Looking at Ulta's 5-point plan, their results may take some time to get full results although the results should be steady. Ulta wants to move from 576 stores to 1,200 nationwide in about 5 years. Considering the new stores have a 2-year payback period and a total return of 340% over five years, the revenue generation for doubling the stores will be significant. Most stores are located or will be located in affluent high population areas that can support the growth of all offered services and products and 33% of new stores will be in new markets. The expansion will help leverage their economies of scale. This growth does not include an increasing presence online, which will drive earnings higher with better margins due to lower overhead. Additionally, the planning and distribution systems are receiving a major overhaul. Stores will now have better labor and merchandise planning to reduce costs and increase the buying experience. The expansion efforts can also be assisted by an undrawn credit of $200 million, however; Ulta plans to use $0.13 from EPS to drive the growth in order to keep Ulta debt free. Adding the new stores and building efficiencies into the systems will create long-term net income growth of 30% and return on equity of 27%. The ability for Ulta to continually generate free cash flow is key for their success and thus far they have been able to achieve that.

New Products and Services

Another point of the plan is to bring in new products, services, and brands. Currently, Ulta offers 20,000 different products from 500 unique brands. They are categorized into prestige, salon and mass product lines to provide needs (and prices) for every customer. Ulta also offers full-service salons, experiential boutiques and testers, and educated beauty advisors to create a differentiated one-stop shopping experience. The full-service salons provide services such as microdermabrasion, nail services, and hair extensions. With the tenured staff, the shopping experience can also vary from receiving help on where to find a certain product or receiving advice on which product or service suits your need all with a low-pressure environment.

Customer Loyalty Program

Along with securing more products for customers to choose, Ulta is enhancing the customer loyalty program. The customer loyalty program is already strong with over 12 million users and a variety of promotions, events, and exclusive products. The 12 million users contribute to over half of Ulta's sales and they tend to have a higher shopping frequency than non-members. Items that the customer uses or may interest them are sent to them when they have a promotion. This sophisticated segmentation of one-on-one marketing keeps consumers coming back without annoying them with useless ploys for their money. Consumers can use it as a tool to find products they like and receive rewards for buying them. Ulta also has a new customer relationship management platform to enhance the shopping experience. They are using apps to more readily connect their customers to products and services. The app allows customers to have the latest in exclusive offers, search beauty information, and buy products quickly all from their phone. The loyalty program works well because it is tailored to each customer as a complement to other marketing strategies.

Marketing Strategy

Due to Mary Dillon's experience in marketing, the marketing strategy is constantly changing to show the consumer why Ulta is the place to buy beauty supplies. The marketing is targeted towards the mid-teen but no one is really left out (even men). This makes the most sense because when they capture the spending of a younger audience they will be customers for life. Ulta is aggressively advertising in print as well as online through social media and online marketplaces. They are marketing in major media to emphasize their position as a beauty authority. Not only will sales increase as Ulta strengthens their lead as a beauty leader but they will gain more beauty brands and better pricing power for the goods they sell.

Survey

Furthermore, I was intrigued by these numbers but wanted to know what real customers thought of Ulta and why they went there. So I spoke with customers and was shocked to hear what they said. They all had a loyalty usually only seen with well-known brands such as Under Armour (NYSE:UA), Nike (NYSE:NKE), Coca-Cola (NYSE:KO) and they are not a producer of the products they sell but a retailer! They loved to find everything beauty-related in one place and have the knowledgeable staff help them find what they need or offer suggestions for upgrading their choices. Everyone I spoke with mentioned the low-pressure setting that as one customer said, "It felt like you were just talking to your best friend." Ulta is the only place many of them go for supplies. It caters to different clientele but no one feels neglected for service regardless of how much they spend.

Conclusion

Ulta is smart because although they have a proven track record, they are constantly and aggressively improving and not resting on their laurels to compete. Under new leadership and with the support of the experienced associates, Ulta will reach new heights.

Disclosure: I am long ULTA. 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.