Ulta Beauty (ULTA 0.09%) investors have recently had to deal with an unexpected turn of events -- underperformance. Since hitting all-time highs over $313 per share in early June, the stock is down over 20%.
Data by YCharts.
The weakness isn't due to any missteps from the company but recent moves by department stores like Lord & Taylor, Macy's, and J.C. Penney to offer large discounts on high-end cosmetics. The moves are somewhat unprecedented in the industry, as prestige makeup has long been an item department stores avoided discounting at all costs. However, in the wake of large declines in mall and department store traffic, drastic measures are now necessary.
Though Ulta stock has sold off heavily on these developments, shareholders need to remember what makes this company so special.
Superior business model
Ulta's recent dominance of the retail cosmetics industry is not merely based on pricing. Its business model is to tear down barriers between high-end prestige offerings and low-end drug store brands, putting them all under one roof. Moreover, the company's stores are largely in shopping centers and strip malls -- not traditional malls where traffic is suffering. That wide selection and convenience is augmented by regular events geared toward "beauty enthusiasts", which makes for a fun in-store experience. These attributes combine with competitive pricing to keep customers coming back.
Enviable loyalty program
Complementing the business model is Ulta's excellent loyalty program, which not only offers customers discounts when they earn points but also allows Ulta to collect data on what customers want. Ulta can tailor inventory and customize discounts on frequently bought items, and these personalization efforts make customers feel at home.
ULTAmate Rewards has been a raging success, expanding to 24.5 million members last quarter, good for a 26% growth rate. The strength of the program makes it less likely that participating customers will go to competing retailers for a one-off discount.
Proprietary items and services
Finally, Ulta has certain products and services that department stores, and even Sephora, do not. For instance, Ulta builds beauty salons right into their stores. While this segment has not performed as well as traditional cosmetic sales, it's still growing, and the company has made a push to upgrade their salon offerings in 2017.
Image source: Getty Images.
Moreover, Ulta will be rolling out MAC makeup counters at roughly 100 locations across the country. MAC is the number one prestige makeup brand in the country and had previously been unavailable outside of MAC's own retail stores and select department stores (not including Sephora). While MAC had traditionally been very selective with their sales channels, in light of Ulta's ability to attract customers (and double-digit comparable sales growth), the companies struck a deal earlier this year.
The MAC partnership is another indication of Ulta's "cool" factor and brand reputation as the place for beauty enthusiasts. That should keep the buzz alive and customers returning, no matter how much competitors may slash prices.
While Ulta stock has always commanded a pricier valuation, that hasn't stopped shares from nearly tripling in the past three years. After the recent sell-off, the stock now trades at 30 times forward earnings estimates. Considering the company grew sales over 22% and earnings per share over 40% last quarter, I think that's a fair price for this industry-leading company.
