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How Ulta Beauty Is Building Loyalty

By Lawrence Rothman, CFA – Jun 27, 2020 at 2:36PM

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Ulta Beauty's quarterly results were poor, but this should prove temporary.

Like many other retailers, Ulta Beauty (ULTA -0.99%) closed its physical stores in mid-March. Predictably, the company had a challenging fiscal first quarter (ended May 2). Ulta's same-store sales (comps), which include the closed locations, dropped 35.3%, and the company had a $101.5 million operating loss compared to operating income of $237.5 million in the year-ago period.

This sounds dismal, but there is a light at the end of the tunnel. The company started opening stores and offering pick-up service at certain locations. At the end of May, more than 25% of its 1,264 stores were open to the public, and two-thirds of its locations provided pick-up service.

Ulta Beauty was doing well before the pandemic, producing positive annual comps since at least fiscal 2003, which is as far back as the public data goes since the company went public in 2007. Last year, its comps were up 5%.

Therefore, the key question is how quickly Ulta can get back on track.

A woman helping another woman at a store with beauty products in the background.

Image source: Getty images.

A loyal customer

Started in 1990, Ulta shook up the beauty industry by offering products at different price points that appeal to various segments of the market. It currently carries over 500 brands casting a wide net to "beauty enthusiasts," which management claims account for 77% of the beauty category's spending in the U.S.

This was a departure from previous industry practices when drug stores and mass merchandisers like Walmart (WMT -0.93%) carried mass products; department stores stocked prestige products; salons and certain retailers sold professional hair care products.

With its wide array of products and services, like salons that provide licensed stylists and aestheticians (skin care specialists) who give advice on hair, skin, makeup, and eyebrows, Ulta has also engendered loyalty. It has over 33 million members in its loyalty program, Ultamate Rewards. Management has found they visit more frequently and have higher spending each time.

No doubt, with Ulta's broad reach and appeal, people will return to the stores as governments lift restrictions. After all, COVID-19 derailed its first quarter's results, and not anything specifically related to the company's actions.

Increasing digital sales

While COVID-19 hurt Ulta's quarterly results, it did find some solace in accelerating e-commerce sales growth, a key component of management's strategy. While Ulta's physical stores are important, allowing visitors to test  products before buying them, developing its digital presence is another channel to reach customers.

Looking to the future, the company's app includes the GLAMlab tool. This allows users to virtually try out thousands of beauty products without leaving home. Naturally, usage increased about fivefold when Ulta shut down all of its stores, but it is good to have in its toolbox. With the company forgoing samples in its stores for safety reasons, the app continues to provide a benefit. Undoubtedly, this will become very useful for customer engagement even when the coronavirus pandemic fades.

Although specific numbers weren't provided, e-commerce sales doubled. No doubt, some will continue to shop online, which bodes well for Ulta's future sales and earnings prospects. As management noted on its first-quarter earnings call, customers who use more than one channel to shop increase their spending at Ulta by almost three times compared to someone who only frequents its stores.

Ulta also has a healthy balance sheet, even after borrowing $800 million in the quarter to boost its liquidity in light of the uncertainty created by the  pandemic. That was the only debt, giving it a debt-to-total capital of 31%. There was $1.2 billion of cash and short-term investments.

Despite a weak quarter, there's a lot going for this company. These include an enviably loyal customer base, strengthening digital capabilities, and a strong balance sheet. In short, the shares are a compelling opportunity.

Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Ulta Beauty. The Motley Fool has a disclosure policy.

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