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Have Investors Been Overlooking Ulta Beauty Inc?

By Demitri Kalogeropoulos – Updated Jul 26, 2017 at 3:36PM

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Brick-and-mortar retail stocks haven't been too popular lately. Here are a few reasons to get excited about this beauty products and salon chain again.

Ulta Beauty (ULTA -0.34%) shares have fallen almost 20% since they reached an all-time high of over $300 in early June. The beauty products retailer and salon chain arguably has room to continue falling, too, given its premium valuation and the likelihood of slowing growth in the future.

However, even for investors who have decided to shun the stocks of retailers with large physical store footprints, ignoring this one would be a shortsighted move. Unlike many of its peers, Ulta Beauty has a good shot at improving sales and profits in the years ahead.

A woman applies face cream.

Image source: Getty Images.

Robust traffic growth

Ulta Beauty's sales jumped 25% last year. And while an expanding store base played a big role in that increase, the spike had more to do with rising foot traffic at its existing locations. The retailer posted an 11% gain in customer transactions, in fact, even as average spending per visit improved by over 5%.

Those metrics -- plus a growing e-commerce business -- combined to produce a 16% increase in comparable-store sales in 2016. The momentum has so far carried through into 2017. Ulta Beauty in late May posted a surprisingly strong 14% comps gain that was derived from 9% growth in customer traffic and an almost 6% boost in average spending. "Strong execution of our growth strategies," CEO Mary Dillon told investors, "delivered above plan sales and earnings growth."

Another sales channel

E-commerce is another huge growth driver for Ulta Beauty. Online revenue spiked 71% in the first quarter following a 56% jump in 2016. Dillon and her executive team plan to grow their online platform to 10% of sales by 2019, up from 7% today.

The good news for investors is that this dramatic expansion isn't pressuring profitability. In fact, Ulta Beauty is managing steady increases in both gross and net margins despite its heavy investment in the online platform and in building out its physical store presence. Net income ticked up to 8.4% of sales last year from 8.2% in 2015 and 7.9% in the prior year.

ULTA Profit Margin (TTM) Chart

ULTA Profit Margin (TTM) data by YCharts

Aggressive expansion plans

After boosting their 2017 sales growth outlook this Spring, Ulta Beauty's management confirmed their plans to add 100 new stores in 2017 and pass 1,000 locations sometime over the next few months. Like Starbucks (SBUX -0.08%), the retailer has aggressive plans to expand its physical footprint by about 50% over the next few years. While most of the coffee titan's growth will come in international markets, though, Ulta Beauty sees room to grow to as many as 1,700 locations in the U.S. alone.

The beauty retailer plans to rely heavily on a loyalty rewards program that takes a page out of Starbucks' playbook. It already boasts 23 million members, and engagement levels are through the roof. Over 90% of sales last year were to customers who were active members of the loyalty program.

Ulta Beauty is on track to boost revenue by 19% this year. Starbucks, meanwhile, is struggling to hit its 10% growth target as its traffic growth tapers off.

Sure, Ulta Beauty isn't in the same league as the beverage titan, which owns one of the most valuable brands in the world and has a diverse range of growth options it can pursue. However, Ulta's focus on creating an exciting customer experience raises some appealing similarities to Starbucks in its earlier expansion days. That strategy seems set to help the retailer soak up market share even as it slowly expands its profit margins through 2019.

Demitrios Kalogeropoulos owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks and Ulta Beauty, Inc.. The Motley Fool has a disclosure policy.

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