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The Big Risk Ulta Beauty Sees for Late 2021

By Demitri Kalogeropoulos – Sep 1, 2021 at 11:00AM

Key Points

  • Sales growth is strong, but customer preferences are shifting quickly.
  • Ulta is targeting a higher profit margin thanks to lower discounting and a trend toward premium products.
  • Management is adding inventory in preparation for a busy holiday season.

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Customer traffic is holding up, but the chain might struggle to keep its shelves stocked.

Ulta Beauty's (ULTA 3.33%) operations are looking prettier with each passing quarter. The retailer of spa and beauty products recently announced the second straight upgrade to its 2021 outlook, following surprisingly strong sales growth.

But it isn't just the booming makeup industry that has Ulta targeting record earnings this year. As CEO Dave Kimbell and his team said in a recent conference call with Wall Street analysts, the chain is seeing a big lift from other trends that might support fundamentally higher profitability from here on out. Yet new risks are also cropping up, including a major challenge around inventory availability heading into the holidays.

Let's take a closer look at at these risks and opportunities ahead for the company:

A young woman applying skin cream in the mirror.

Image source: Getty Images.

Setting the stage

There's no question that Ulta is enjoying the best selling environment it has seen in years. The makeup industry came roaring back last quarter, and those improvements only accelerated through late July. "The beauty category is recovering faster than we expected," Kimbell said. "As consumer confidence, optimism, and comfort to shop in physical stores continues to increase, we are seeing more of our members return to stores."

Customer traffic is still below 2019 levels, but Ulta Beauty more than offset that headwind by securing much higher average spending per visit. It also has a booming digital selling channel. Overall, sales for the quarter ended June 30 totaled $2 billion compared to $1.2 billion last year and $1.7 billion in 2019.

A different market

There were significant demand shifts within that broader growth picture. Makeup sales are up only slightly when compared to 2019 while niches like fragrance, bath, hair care, and skin care have all surged higher.

Ulta succeeded in that volatile environment by keeping a lean inventory and quickly shifting its merchandising strategy at times. Management credits its omnichannel selling platform for keeping customers engaged, but also says the in-store experience is a key competitive advantage.

"Discovery and trial are critical parts of the beauty experience," Kimbell said, "and we offer a variety of physical and digital ways to discover new products, new trends, and new applications."

The biggest risk is empty shelves

As Ulta management sees it, the first half of 2021, along with the first few weeks of the third quarter, imply a strong finish to the year. The company now expects to achieve a 13% operating profit margin, aided by higher sales, reduced promotions, and a shift toward more premium products.

Ironically, besides COVID-19 outbreaks, the biggest risk that management sees in the short term is the challenge of securing enough inventory to handle demand over the next six months. Shipping delays are common today and could become worse with rising virus cases.

But Ulta believes it is taking the right steps to keep inventory flowing, even if it means holding too much at stores over the next quarter or so. "Our teams are working diligently to mitigate risk, and where appropriate, we are proactively working with our brand partners to prioritize receipts to ensure we have adequate inventory for the holiday season," CFO Scott Settersten said.

That strategy means investors will see elevated inventory levels in the third quarter that should come right back down in the following quarter if the industry continues growing as it has so far in 2021.

Demitri Kalogeropoulos 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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