Deep dive into Ulta Beauty ($ULTA)

Disclaimer: I do NOT have a position in the company.

1.0 Introduction

Ulta Beauty had impressive growth and is now the largest specialty beauty retailer in the U.S. with a presence in 50 states.

However, the growth in locations seems to have significantly decelerated since 2020, which coincides with the start of the pandemic.

2011: 449 stores

2012: 550 (+22%)

2013: 675 (+23%)

2014: 774 (+15%)

2015: 874 (+13%)

2016: 974 (+11%)

2017:1074 (+10%)

2018: 1174 (+9%)

2019: 1254 (+7%)

2020: 1264 (+1%)

2021: 1308 (+3%)

2022: 1355 (+4%)

2023: 1385 (+2%)

2.0 The Secret To Its Success

Let’s start by looking at the formula for its success, which I think can be attributed to 2 factors:

1. The company has a portfolio of over 25,000 products from 600 brands (including its private label). It is a one-stop shop for those who are looking for a product in any of these areas:

2. This has allowed them to grab the attention of many, and convert them into loyal members, by offering them “Ulta beauty rewards“.

Combining a wide portfolio offering with a good loyalty program leads to many recurring customers. In fact, the “Ultamate Rewards members“ account for 95% of all the sales!

If you take a look at the share price of the company, there's a high correlation with the stores' growth. From 2010 until Feb 2020, the share price went up roughly 1,500%. Since then, it is up only 36% (vs. 68% S&P500).

The key question there is – Will the growth re-accelerate?

3.0 The Potential Growth Drivers

One of the most obvious drivers is – an increase in the number of stores. Around 1/3rd of all the stores (~500) are so-called “shop-in-shops“ in Target stores.

Based on the long-term target of the company, there’s still room to grow in the U.S. by:

• Adding 600 more freestanding stores

• Adding 300 more Target shop-in-shops

When it comes to international sales, there’s little information, other than the planned expansion into Mexico starting in 2025. However, this is a very uncharted territory, and I’ll come back as to why. The growth in the last year has been ~40 stores/year (~3%) and I think it is fair to expect similar growth ahead.

The second growth driver, in theory, is – portfolio expansion. Given the size of over 25,000 products, this is unlikely to be a significant growth driver. Expanding from 25,000 products to 50,000 won’t lead to 100% additional revenue, but likely to customers substituting one product for another.

Similarly, if you go to the supermarket to buy bread, the number of choices you have there won’t influence the quantity you intend to buy.

Lastly, inflation. If it stabilizes at 3%, well, this will eventually reflect in the company’s revenue. Yes, it will also be reflected in the direct costs as well as the operating expenses.

Based on the above, I expect the future revenue growth to be around 6%, at least in the near term. However, some concerns need to be addressed.

4.0 The 3 Key Concerns

4.1 Competition

Yes, every company (and industry) has competition. However, as Ulta Beauty is partnering with Target, Sephora is partnering with Kohl’s. There is Bath & Body Works, there’s Beauty Elf, and there is a lot more. Since the portfolio is so broad, Ulta Beauty is competing with:

• Traditional department
• Specialty stores
• Grocery stores
• Drug stores
• Mass merchandisers
• eCommerce companies

And the list goes on.

This sounds scary, but I’m least concerned about this, as I do think being a one-stop shop has its competitive advantage, at least in the U.S. – The company has proven it does a good job and knows how to win against its competitors.

However, when it comes to international growth, the level of my concern increases significantly.

4.2 Discretionary products

The company sells non-essential goods and services. People can cut back on them, replace them with cheaper substitutes, or eliminate them when times are rough. This can be best illustrated by the impact of the pandemic, where the revenue dropped by 17%.

4.3 Low Employee Satisfaction

Employees are key for a company of this kind. I use various sources to get some input on employee satisfaction (such as Indeed, Glassdoor, and Comparably).

The overall rating isn’t great. What I find worrying is the context of the 1-star reviews.

I should point out – not every 1-star review is the same. For example:

If someone works in a warehouse, and the reason for the 1-star review is “I have to be on my feet all day“ – Yes, that is unfortunately, it is a tough job. But it indicates a mismatch between the employee and the role, and it doesn’t say much about the company.

Similarly, if a salesperson gives a 1-star review because “The customers ask questions“ – Again, this is a mismatch between the employee and the role.

However, these reviews are completely different, and there are plenty of them. Ranging from toxic culture and too much gossip to no work-life balance and management favoritism.

As these are mostly positions that do not require any significant specialization, the management doesn’t pay too much attention, and despite the high turnover, there is replacement relatively quickly. The question is – Would this approach work internationally – in completely uncharted territory?

International expansion is in my opinion – the key risk. Based on all the insights I have, I am not convinced they can expand quickly with comparable success.

5.0 The Historical Financial Performance

Despite all of this, the company’s financials are solid, with stable margins over time. In the last twelve months, the revenue grew to $11.3 billion, with an operating profit margin of 14.5%.

As there is no aggressive growth through opening new stores, you might ask – where is all the cash going?

The answer is – Share buybacks.

The company’s shares outstanding have decreased by 25% over the last decade.

6.0 Valuation

Based on my assumptions, the fair value of the company is slightly above $18 billion ($377/share), not that far from today’s price.

The two key assumptions relate to the revenue growth and the operating margin. Here’s my rationale:

1. Revenue – As indicated above, I do expect that the growth will continue in the U.S. and I do think it will accelerate, once the consumer sentiment has recovered. I don’t see any reason for Ulta Beauty to not continue its store expansion domestically. So, my assumption is not far from the 6% revenue growth per year.
2. Operating margin – Every company with a retail location wants to find “the best location“. Then, the 2nd best location, then the 3rd best, and so on. I do think the economics of the future stores won’t be as appealing as the past ones. This combines my outlook on the international expansion that could turn out to be (un)successful. My assumption is an operating margin of 14%.

Here’s how the valuation (per share) changes if you have different assumptions than mine, regarding the revenue growth over the next decade, and the operating margin:

Revenue / Operating margin	14%	15%	16%	CAGR (Revenue)
50% ($17.b)	$310	$365	$420	4.1%
76% ($19.8b)	$377	$446	$514	5.8%
100% ($22.6b)	$418	$494	$571	7.2%

As I’m writing this, the current share price is $410. The market implies around 6% expected annual growth with similar margins as the past years. That means, there is no value expected from the potential international expansion.

If you believe the company can execute the international expansion successfully, then there’s a case to be made, that Ulta Beauty is undervalued.

I hope you enjoyed this post, feel free to share your thoughts.