Ulta Beauty (NASDAQ:ULTA) made a splash in the crowded beauty retail scene when the company started in 1990 and has produced an enviable track record of same-store sales gains. The company went public in 2007 and has reported positive annual comps since fiscal 2003, which is as far back as the data goes in the company's annual reports.

At a time when the retail industry has been impacted by consumers shifting more of their shopping online, Ulta's sales more than doubled from fiscal 2014 to fiscal 2018 while the bottom line increased by even more. Ulta's diluted earnings per share growth was more impressive as the company has been repurchasing shares. The company's 2018 fiscal year ended about a year ago and FY 2019 results are expected to be reported on March 12.

Metric FY 2014 FY 2018 Change
Sales $3,241 $6,717 107%
Net income $257 $659 156%
Diluted earnings per share $3.98 $10.94 175%

Data source: Ulta Beauty. Dollar figures in millions, except diluted earnings per share.

Ulta's sales growth continued in its most recent quarter, which ended Nov. 2, 2019, increasing by 7.9% year-over-year, thanks in part to a 3.2% increase in comps. The company attributed the comps growth to higher traffic (2.3 percentage points) and increased spending (0.9 percentage points). Net income was down a bit compared to the year-ago period, from $131.2 million to $129.7 million due to higher selling, general, and administrative expenses. This was partly from spending on growth initiatives in digital areas and international expansion. Given the company's successful sales growth track record, I have no doubt that this one quarter will prove a net-income aberration.

How does this 3-decade-old company continually grow revenue in the competitive beauty industry? It does a lot of things well that, when combined, make Ulta Beauty a formidable company.

 

A young woman applying makeup while looking in the mirror

Image source:Getty Images.

Something for everyone

Ulta shook up the industry by selling many brands at different price points, thus appealing to a wide audience. Previously, the beauty industry was segmented into different categories that were sold at specific types of retailers. Prestige products were sold in department stores; mass products were found in drugstores and mass merchandisers such as Walmart; professional hair care products were sold in salons and certain retailers.

Now, with roughly 500 brands, including its own private label, spanning more than 25,000 products across the prestige and mass categories, if you are looking for a beauty product, Ulta is likely to have it in stock. Cosmetics is its largest category, representing 51% of its sales but there is also skincare, bath & fragrance; haircare products and styling tools; salon services; and nail products and accessories.

Ulta notes that the majority of its stores are in "power centers," which are shopping areas with three to five big-box stores and smaller specialty stores. It has a smaller presence in malls.

In addition to selling a breadth of products that its competitors don't, Ulta aims for a shopper it deems a beauty enthusiast, who is "passionate about the beauty category and has high expectations for the shopping experience." This is a good group to target since, Ulta says, they account for 77% of beauty spending. And Ulta is aiming to give them more than just an array of products to choose from.

Drawing customers

Ulta continues to focus on the customer experience with a consumer-friendly concept and store layout.

Placing salons in each of its stores (currently, over 1,200) has long been a part of Ulta's strategy. . These offer services including hair, skin, and eyebrow work, from licensed professionals. This lets the company promote products and builds rapport with customers. Ulta has made a significant investment, with roughly eight to 10 stations in each store. There are features such as a concierge desk and a skin treatment room. In short, the professional stylists and skin care experts create a connection with the customer. The proof is in the result. Management finds that those who visit an Ulta salon are more frequent shoppers, spending about three times more than non-salon customers.

Ulta has also been building out its e-commerce platform. Its omnichannel approach, which involves letting customers shop in its stores and via its mobile app and website, is not unique, but the company is executing well. E-commerce comps increased at rates ranging from 35% to 60% annually from fiscal 2014 to 2018. The company no longer breaks out e-commerce sales in its reporting, but management said that third-quarter year-over-year growth on ulta.com was at the low end of its 20%-30% expectation  and that is still impressive. Those that shop both online and in stores are valuable customers, too. The company says they spend approximately three times that of a shopper who only visits a physical store.

Ulta's efforts have created a loyal customer base. At the end of the third quarter, there were about 34 million customers that were part of the Ultamate Rewards program, up from about 32 million at the start of the year.

These members accounted for more than 95% of Ulta's sales and the company has found that loyalty program members both shop and spend more than those who aren't members. The program provides the company with data it uses to effectively target promotional and marketing activity.

More growth ahead

Ulta CEO Mary Dillon told analysts on the Dec. 5 conference call that the company is facing cyclical headwinds "resulting from a lack of incremental innovation and compelling newness." She said that "our main thesis is that there just isn't as many items that people are adding to their basket that are ... new rituals ... like contouring or doing your brows. So people are buying lots of makeup, and we'd say, engagement in the category is still quite high, but just not at the level it was with the kind of newness that we'd seen for a few years. That's all solvable."

Management estimates the combined U.S. beauty products and salon services market at $145 billion. With Ulta's approximately $7 billion in annual sales , there is room for the company to continue gaining market share.

Ulta has been adding about 100 new stores annually for the last few years. Management is planning on 70 to 80 stores for the next several years, estimating it can increase the number to 1,500 to 1,700.

Ulta's approach is clearly working. The higher sales and profitability have led to strong cash flow generation, and it has used part of this to repurchase shares. For the first nine months of 2019, it spent $507 million for these purposes. Thus far, paying an average price of about $309, it looks like not a good use of capital as the stock has been trading under $300 for several months.

Meanwhile, Ulta has achieved its growth while keeping its balance sheet clean. Not that I'm expecting one, but this gives the company more breathing room in case of a hiccup.

In short, this is a company that continues to execute its plan and search for new avenues of growth. It has embraced influencers, notably Kylie Jenner, who signed an agreement in 2018 that made Ulta the sole retailer carrying Kylie Cosmetics.

A price-to-earnings ratio (P/E) of 25 is roughly in-line with the S&P 500's P/E ratio. Hence, it is not overly expensive, but it is not a bargain, either. It is hard to argue with paying full price for a quality company, though.