Cosmetics have been a part of human culture as far back as history goes. Everyone wants to look beautiful, and this desire has created a thriving industry worth more than $90 billion in the U.S. alone.
Ulta Beauty (ULTA -2.08%) is the largest cosmetics retailer in the United States. Down 5% since January, the stock has struggled in recent months. However, there are two significant reasons why Ulta is poised to be a long-term winner for investors.
Long-term revenue growth intact
Ulta Beauty has consistently grown its revenue over the past decade, averaging 17% per year. You can see the smooth upward trend in the graph below, and even when COVID-19 disrupted the business by keeping shoppers out of many stores, the company rebounded in 2021. You can almost take a pencil and "draw" a line over the 2020 dip, and its 2021 revenue of $8.6 billion falls almost perfectly on a long-term trend line.
ULTA Revenue (TTM) data by YCharts
Ulta goes to market in multiple ways, including stores, wholesale to other retailers, and e-commerce. Additionally, its brands span three price tiers: mass population, prestige, and "mass-tige," a middle-ground.
Younger consumers could continue to drive demand for Ulta's products. The company's market research survey estimates that Gen Z (aged 25 and under) women and girls are more enthusiastic (78% of those surveyed) about beauty products than other age groups (60% across the general population).
The company's expecting a slow-down in growth for 2022, guiding for 3% to 4% year-over-year increase. However, investors shouldn't panic because 2021 was a rebound from COVID-19, where revenue grew 40% over 2020; it's a tough number to follow. Investors should look for revenue growth to pick up in 2023 and beyond as things get back to normal.
Becoming increasingly profitable
You want to see a business become more profitable as it grows, and Ulta is progressing nicely. The below chart shows free cash flow as a percentage of revenue. In other words, if a business has one dollar in revenue, how much of it is cash profit? In 2016, Ulta would only get about two cents from each revenue dollar. But today, that's increased to 10 cents, a massive improvement!
ULTA Free Cash Flow (% of Annual Revenues) data by YCharts
The gradual increase in the percentage shows that its current profitability isn't just a short-term coincidence -- the business has steadily become more profitable as it grows larger.
Ulta, like many companies, is dealing with inflationary pressures, so you can see this metric trail off a bit recently. These challenges are widespread, and I'm encouraged by how Ulta's profitability has held up against them. I would anticipate that as supply-chain problems fade, profitability would continue to inch higher over the long term.
With increased profitability and a growing top line, Ulta's 2021 free cash flow was $887 million, which the company used to repurchase shares ($1.5 billion worth over the past year) and bolster a balance sheet that has $431 million and almost no long-term debt.
Investor takeaway
A company that can grow and become increasingly profitable at the same time can be an excellent compounding machine that investors should appreciate. Ulta Beauty is a simple but effective business with a strong presence in one of society's oldest industries.
Investors will always want to monitor what they own, and a prolonged drop in revenue growth or inability to generate free cash flow would be potential warning signs. But if the business performs as it has over the years, Ulta Beauty might be a stock you can hold and sleep well at night.
