I wanted to do an extensive write-up of ULTA before earnings came out yesterday, but naturally things came up and I was left with limited time. However, I still wanted to publish something, to disclose my long position and belief in this company’s future success. I found ULTA through inference investing, a concept I will introduce in the next paragraph before my brief ULTA analysis. If you don’t care to read about this concept, then scroll down to “Onto ULTA”, however what I say about ULTA all relates back to that concept.
Last semester, one of my professors taught me about this interesting idea. He stressed the importance of students taking a step back from the digital world and keeping a comparative eye open to look for market trends, anomalies, and inefficiencies in our daily lives. The next step is drawing inferences, applying those findings to investment strategies and conducting valuation analyses to determine whether the price is right. A bad example would be someone investing in Amazon with this strategy. Someone could say, “Well, my friends and I use Amazon all the time, they’re constantly expanding into different industries, and they seem like they’ll keep growing, so let’s buy Amazon.” The point is to find smaller companies, or those trends and anomalies that others aren’t following as much.
Anyways, after 2 weeks of searching, there were 2 that I liked the most; mine, which was Chegg, and my friend’s, which was Canada Goose. Chegg is a textbook renter/seller and sends their textbooks to students in bright orange boxes. I found these boxes in many of my friends’ dorm rooms and remembered the hundreds of orange boxes I saw at the school’s post office at the beginning of the semester. I asked many people about their overall experiences with Chegg, which were seemingly all great, and did some research into their background and financials. I found this small-cap with huge market potential, growing sales and increasing profitability. In the last 6 months, the stock has skyrocketed over 75%. The other example I want to use is Canada Goose. My friend noticed that there were more and more people wearing their winter jackets on campus. In February he found they were privately held, but would complete an IPO in March. He believed their IPO valuation was reasonable and had a strong feeling their sales were growing. He initiated a position within a week of their IPO and realized 30%+ gains within 4 months. Obviously these are two great success stories, but it shows that this concept can work. You can find both growth and value stocks through inference investing.
After learning about interest investing, I went to my girlfriend Lindsay to learn about some of the things she uses or sees every day. Like most females, she uses makeup every day, so I had to ask where she buys it all. She told me she buys most of it at ULTA, along with her mother and many of her friends. I had to learn more about this beauty retailer and what she liked most about their stores.
Pathway to Sales
First, she told me about the layout – how it is easy-to-navigate, but also sends consumers on a path where one thing leads to the next. For example, once they find their eyeliner, right behind them or next to them is the mascara, eyeshadow, etc.. They are enticed to buy more than they came in for. In addition, the store puts the beauty “wants” in the front, and the beauty “needs” in the back, so that customers get exposure to those other products that they didn’t necessarily come in for, most likely increasing their sales. Also, they have a diverse range of products, carrying both brand names and discount/generic names. It is said that the drugstore/discount brands they carry are sold at a higher price than say Walmart or Target, however they are in the business of selling the high-quality, brand name products.
Not Just Makeup
She also told me about how there is a salon in every store, offering not only hair and makeup services, but skin and nail services as well. The average ULTA store is roughly 10,600 square feet with 900-1,000 square feet dedicated for the salon space. Last quarter, salon sales grew by 16.7%, or $10M. This may be small relative to entire sales dollars, however these affordable services are just another way to drive store traffic, likely increasing product sales. Furthermore, with haircare products, ULTA is more diverse than their main competitor – Sephora. Sephora offers a similar product selection but can’t match ULTA’s loyalty program.
My girlfriend also praised their industry-leading “Ultamate Rewards loyalty program”, where every dollar spent translates into one point, with bonus points offered around certain times of the year. Apparently, they also have extremely appealing Black Friday deals. An impressive 90% of sales come from loyalty program members, suggesting that these customers love ULTA and continue coming back for more. In Q1 2017, YOY growth in loyalty members was up 26%.
Defying the Amazon Effect
Lastly, I believe ULTA has the ability to defy the Amazon effect, or Amazon’s ability to put retailers out of business with lower costs and without a storefront. ULTA is a different breed of retailer, primarily because it is difficult to sell makeup online. If customers don’t know exactly what product they’re looking for, they want to go into the store to explore options, and see and feel the makeup. Amazon may only be a good option if they know exactly which product they want. However, Amazon has had issues lately with counterfeit makeup – poor quality fakes causing facial rashes and problems. With the recent push by all retailers to go the e-commerce route, ULTA has followed and has continued to increase online sales. Online sales grew more than 50% last year. And one last thing to mention is ULTA operating mostly out of power/strip malls and not in traditional malls. Consumers are going to traditional malls less and less, which doesn’t seem to have an impact on ULTA since they aren’t located there.
All of this information above were “soft factors” or not exactly things normally discussed when finding an investment. Inference investing helped me find this company and I hope to see growth continue!
ULTA’s sales have grown over 20% each year since 2012 with a 22.3% CAGR. Cost of sales grow consistent with the sales growth as expected, however could they eventually lower these to raise gross margins? Same-store sales grew 15.8% last year and they have more than doubled their number of stores in the last 5 years, adding over 100 stores each year. Operating and net margins have only steadily expanded since 2011, from 6.77% to 8.4% last year. In 2017Q1 they posted their highest net margin ever, of 9.75%! Last year operating cash flow grew 68% and free cash flow 240%. This quarter they announced similar results of 20% sales growth YOY, widening margins, and significant e-commerce growth of 73%. EPS grew a staggering 28%.
With “soft factors” mentioned above, a history of crushing sales and earnings, down 25% from 52 week high and setting a 52 week low yesterday, I believe ULTA has huge long-term upside potential. I didn’t really get to talk exact valuation in this article, but signs point to a great long opportunity here. It is worth noting that the company has no debt and has been aggressively repurchasing shares in the last few years, slowly increasing the value of each share. I am long with an average of $240/share and may scoop up a little more at a discount today from an interesting reaction to earnings. Not much has changed for ULTA since they reached a high of $314 and it looks like nothing can get in the way of this growth path.
Disclosure: I am/we are long ULTA.