ULTA - Ulta Beauty

[chompsterama]

What's this business got that's special? 

 

Yes, they've ridden a huge wave of makeup/hair/beauty exploding and sometimes being in the right place is all it takes for a while.  But management (as per the most recent CC) is admitting that the tide is turning and the wave shrinking.  I don't know they have anything special beyond that.  Maybe they do. 

 

Here's the thinking:  The business sells mostly third party products and caters to makeup and hair (both styles of which don't change often - most people keep their makeup/hair routine for years once they find what works).  Once a customer finds their favorite dermalogica, clairol, elf, clinique products why should they come back to Ulta?  There are zero switching costs and the business sells almost nothing proprietary.  I mean I like my local tennis shop (that isn't around anymore), but I am not paying $6/sleeve of Penn balls when Walmart or Amazon sell them for $2.50. 

 

In the end, the lowest cost seller will win the business because they are selling someone else's stuff.  I doubt Ulta will be the lowest cost over the long-run.  How can they be?

 

Dude,

 

Have you watch any of the make up tutorials on Youtube?  There are non-binary/gay men/young boys who make a full time living off tutoring women on applying make ups.  The ability of these individuals to make a living is due to the fact that there is a ton of females who are wearing a lot of make up. 

 

10-15 years ago, I may look at an attractive black female and notice the bumps and imperfections in her skin.  In the last 5 years, I have notice a lot more African American females who have great contours and very smooth skins.  They look glamorous and I am sure that the upkeep is expensive.  But who wants to show bumpy skin once they have a taste of that smooth silky skin? 

 

Have you bought cosmetics?  It's an experience!  I'm not talking about a guy who goes to the pharmacy and look at Nivea shave cream vs Harry's.  Kylie Jenner and Rhianna have over 20 different skin tones.  Rhianna has an albino cosmetic.  It's about inclusivity and body positivity.  We all think it's bullshit.  Try to convince me to pay $10,000 for a handbag or $250,000 for a Ferrari.  No way in hell.  But there are buyers out there for it.  It is nice to go to a cosmetic store and try out different shades, tones, and foundations.  It's an experience. 

 

No dog in this fight.  But just like to rant.

 

I appreciate your optimism for youtube and makeup tutorials, Dude.  It's obvious this strange phenom HAS been huge and has probably driven consumers to try then buy products at ULTA.  My point is that management thinks that wave is shrinking.  And going with the tennis ball analogy, doesn't that mean that ULTA could have a negative selection bias?  When someone wants to experiment every few years with changing their makeup they go to Ulta and get a demo, ULTA fronts the cost for the demo and product and MUA then the customer buys their tennis balls from the cheapest seller thanks to ULTA helping them find which ball they like best?  I just can't sort out why ULTA would be that sticky six months after I've found my ideal dermologica product.  I'm going to Google to find whoever will sell it to me the cheapest. 

[BG2008]

What's this business got that's special? 

 

Yes, they've ridden a huge wave of makeup/hair/beauty exploding and sometimes being in the right place is all it takes for a while.  But management (as per the most recent CC) is admitting that the tide is turning and the wave shrinking.  I don't know they have anything special beyond that.  Maybe they do. 

 

Here's the thinking:  The business sells mostly third party products and caters to makeup and hair (both styles of which don't change often - most people keep their makeup/hair routine for years once they find what works).  Once a customer finds their favorite dermalogica, clairol, elf, clinique products why should they come back to Ulta?  There are zero switching costs and the business sells almost nothing proprietary.  I mean I like my local tennis shop (that isn't around anymore), but I am not paying $6/sleeve of Penn balls when Walmart or Amazon sell them for $2.50. 

 

In the end, the lowest cost seller will win the business because they are selling someone else's stuff.  I doubt Ulta will be the lowest cost over the long-run.  How can they be?

 

Dude,

 

Have you watch any of the make up tutorials on Youtube?  There are non-binary/gay men/young boys who make a full time living off tutoring women on applying make ups.  The ability of these individuals to make a living is due to the fact that there is a ton of females who are wearing a lot of make up. 

 

10-15 years ago, I may look at an attractive black female and notice the bumps and imperfections in her skin.  In the last 5 years, I have notice a lot more African American females who have great contours and very smooth skins.  They look glamorous and I am sure that the upkeep is expensive.  But who wants to show bumpy skin once they have a taste of that smooth silky skin? 

 

Have you bought cosmetics?  It's an experience!  I'm not talking about a guy who goes to the pharmacy and look at Nivea shave cream vs Harry's.  Kylie Jenner and Rhianna have over 20 different skin tones.  Rhianna has an albino cosmetic.  It's about inclusivity and body positivity.  We all think it's bullshit.  Try to convince me to pay $10,000 for a handbag or $250,000 for a Ferrari.  No way in hell.  But there are buyers out there for it.  It is nice to go to a cosmetic store and try out different shades, tones, and foundations.  It's an experience. 

 

No dog in this fight.  But just like to rant.

 

I appreciate your optimism for youtube and makeup tutorials, Dude.  It's obvious this strange phenom HAS been huge and has probably driven consumers to try then buy products at ULTA.  My point is that management thinks that wave is shrinking.  And going with the tennis ball analogy, doesn't that mean that ULTA could have a negative selection bias?  When someone wants to experiment every few years with changing their makeup they go to Ulta and get a demo, ULTA fronts the cost for the demo and product and MUA then the customer buys their tennis balls from the cheapest seller thanks to ULTA helping them find which ball they like best?  I just can't sort out why ULTA would be that sticky six months after I've found my ideal dermologica product.  I'm going to Google to find whoever will sell it to me the cheapest.

 

This is such a man's way of thinking...men seeks efficiency and lowest price...women seeks adventure and discovery and all over again

[KCLarkin]

What's this business got that's special? 

 

Yes, they've ridden a huge wave of makeup/hair/beauty exploding and sometimes being in the right place is all it takes for a while.  But management (as per the most recent CC) is admitting that the tide is turning and the wave shrinking.  I don't know they have anything special beyond that.  Maybe they do. 

 

Here's the thinking:  The business sells mostly third party products and caters to makeup and hair (both styles of which don't change often - most people keep their makeup/hair routine for years once they find what works).  Once a customer finds their favorite dermalogica, clairol, elf, clinique products why should they come back to Ulta?  There are zero switching costs and the business sells almost nothing proprietary.  I mean I like my local tennis shop (that isn't around anymore), but I am not paying $6/sleeve of Penn balls when Walmart or Amazon sell them for $2.50. 

 

In the end, the lowest cost seller will win the business because they are selling someone else's stuff.  I doubt Ulta will be the lowest cost over the long-run.  How can they be?

 

They have twice as many rewards members as Starbucks. Maybe there is more to this business than tennis balls?

[BG2008]

I talked to my wife at dinner tonight about Ulta and cosmetics.  I told her about the tennis ball analogy and she told me that girls will own over one hundred lipsticks.  I asked her why?  She said "they brands will market them as limited color, limited edition, limited tone, etc"  She says that they are available all the time. But girls are "gatherers"  and FOMO is very real when it comes to acquiring that supposedly limited edition lipstick. 

 

I don't get it.  It doesn't make sense.  But why do people spend $13 on a pack of smoke?  But people do it. 

[writser]

This is such a man's way of thinking...men seeks efficiency and lowest price...women seeks adventure and discovery and all over again

 

That is such a man's way of thinking..

[BG2008]

This is such a man's way of thinking...men seeks efficiency and lowest price...women seeks adventure and discovery and all over again

 

That is such a man's way of thinking..

 

You got me good

[wescobrk]

down to $227 a share in after hours...

[KCLarkin]

Own the brands, L'Oreal, EL, LVMH etc. EM and travel is where the growth is at, not the US.

 

Thanks for this. I am warming up to the brands, but not willing to pay current prices. I recently watched a Fundsmith video where they named L'Oreal as the one stock in the universe they would own forever. Not sure I agree, but they made a compelling argument.

 

I'm currently reading a phenomenal interview with Bill Stewart in Graham & Dodsville:

https://www8.gsb.columbia.edu/valueinvesting/sites/valueinvesting/files/Graham%20&%20Doddsville_Issue%2036_vF.pdf

 

One of the things that struck me from the interview is how many phenomenal growth stocks over the years have been retailers: Home Depot, CVS, Walmart, Costco, TJX, Dollar General, Tractor Supply, Lululemon, Alimentation Couche-Tard, Ulta come immediately to mind. Over most time periods, several of the best performing stocks are retailers. For example, Kiplingers has a list of the top performing S&P 500 stocks over a 50 year period. Four of the top fifteen are retailers:

 

4. Dollar General

7. Lowe's

13. Walgreen's

15. TJX

 

Notably, there aren't many company's from the "growth" sectors like technology and healthcare. ADP at number 10 was the closest to a "technology" company in the top 15. And only two healthcare companies (Abbott and Medtronic) made the top 15.

 

There is something about retail (insert past performance caveat here) that allows for long periods of sustainable growth even though retailing is very competitive and the moats are squishy at best. Part of it is the simple growth formula of SSS + store openings. Operating leverage probably plays a role too.

 

Obviously, retail is a terrible business. But there are a few select companies that can unlock a sustainable growth formula. I think Ulta is one of them and I think the current pessimism will create a tremendous buying opportunity. I currently have a 2.5% starter position but hoping for further weakness.

 

Management seems top-notch, the strategy is sound, substantial white-space remains. And, as evidenced by some of the comments on this thread, the company is deeply misunderstood.

[Cigarbutt]

Thank you for this very interesting retail idea.

There may have been a 'wave' which is hard to assess for the long term but ULTA has taken a lot of good decisions in order to build significant market share along the way.

Is this a Walgreen moment, a simple temporary lull of 'innovation' in the cosmetics market or somewhere in between?

 

Like Costco, TJX and some others, ULTA has been able to focus on a specific segment of customers with impressive growth (top line AND bottom line) and some of this is likely to be enduring as they and their respective market keep evolving, despite the expected growing online threat (vs brick and mortar stores). They also have built what seems to be a very efficient loyalty program.

For valuation, I try to see what sales and net profit margins will be in five years and put a relative multiple on earnings then, and discount to now with additional discounting of free cash flows generated in the interim (which will be used for share buybacks presumably which adds another layer of uncertainty since the buybacks have not been done opportunistically in the past and returns on future buybacks will be related to multiples applied by the market).

 

A concern I have is the moving target of the number of stores in the US vs potential residual retail white space. Years ago, management implied a threshold at around 1000 stores, then 1200, then 1400 to 1700 stores. There is concern for cannibalization of sales and lower profitability for new stores. Unlike Costco which provides avg sales per warehouse vs year opened, I didn't see anything similar coming from ULTA (apart from occasional individual store maturation curves and a two-year payback objective) and wonder if the lower profitability and the context of the announcement may not be related to the realization that expansion plans will have to be adjusted. Also, remembering how Target fared in Canada, international expansion is not a guaranteed slam dunk.

 

All in all, despite the segment and despite the need to understand what certain customers really want, ULTA has built a significant franchise but I expect growth to be lower and consider that the recent net profit margins are not sustainable. It will be interesting to see how sales and profits line up for Q4, which is the most important quarter of the year.

 

[KCLarkin]

Also, remembering how Target fared in Canada, international expansion is not a guaranteed slam dunk.

 

Target's failure was a unique situation. They bought a failing discount department store's leases and opened up stores across the country. They didn't take time to localize their product or setup distribution. The execution was so awful, they completely destroyed their brand in Canada.

 

Ulta is going slow-and-steady, so they won't make that mistake. In Canada there is already a dominant retailer that carries both mass and prestige cosmetics - Shopper's Drug Mart. It will be interesting to see if Ulta can differentiate itself. Access to exclusive direct-to-consumer brands might help.

https://www.retail-insider.com/retail-insider/2019/7/makeup-monopoly-a-look-at-ulta-beautys-canadian-competitors

 

 

 

[kab60]

I think this is a very interesting situation. It reminds me a bit of the Amazon scare in 2017 when temporary headwinds were interpreted as secular headwinds and a lot of quality retailers were left for dead (or when e.coli hit Chipotle).

 

You have a proven formula and a recipe for longterm earnings growth through SSS, new stores and operating leverage with fabolous economics.

 

And then you get a free option from international expansion as well as an activist taking a stake (debt free, so two years of FCF plus leverage up to 2xebitda would yield plus $4b or enough to retire around 30 pct. of shares at current level).

 

I wonder whether there's a longer term tailwind for "experimental" retailers like ULTA, since Amazon and the like makes it easier/quicker to do all the boring shopping - thus freeing up time to do the fun shopping. Or whether or not the (exaggerated) death of retail will work to deflate leasing costs.

[kab60]

Wedgewood on Ulta: https://seekingalpha.com/article/4300543-wedgewood-partners-ulta-beauty-inc

[kab60]

Working out pretty well so far. Quiet impressed by management. Combo of operating leverage, share repurchases, market share growth as well as SSS increases and new stores is a lot of things firing in the right direction. Longer term you seem to have favorable demographics, makeup possibly returning to growth and international expansion. Anyone have a view as to why/why not this would work outside the US? That's possibly hugely valuable but also pretty unknowable.

[DooDiligence]

Boots has done pretty well here.

 

Is there room for more?

[KCLarkin]

Working out pretty well so far. Quiet impressed by management. Combo of operating leverage, share repurchases, market share growth as well as SSS increases and new stores is a lot of things firing in the right direction. Longer term you seem to have favorable demographics, makeup possibly returning to growth and international expansion. Anyone have a view as to why/why not this would work outside the US? That's possibly hugely valuable but also pretty unknowable.

 

No surprises this quarter, which is great.

 

Ulta worked well in the U.S. because the Mass/Prestige brands had distinct channels (drug store/department store). Ulta built its business by offering both. In Canada, Shopper's Drug Mart already carries both mass and prestige. In the UK, I believe Boots does as well. Given Ulta's market share and exclusives, I think the international opportunity is real. But it is not guaranteed and will be a slow build.

[KJP]

Own the brands, L'Oreal, EL, LVMH etc. EM and travel is where the growth is at, not the US.

 

One of the things that struck me from the interview is how many phenomenal growth stocks over the years have been retailers: Home Depot, CVS, Walmart, Costco, TJX, Dollar General, Tractor Supply, Lululemon, Alimentation Couche-Tard, Ulta come immediately to mind. Over most time periods, several of the best performing stocks are retailers. For example, Kiplingers has a list of the top performing S&P 500 stocks over a 50 year period. Four of the top fifteen are retailers:

 

4. Dollar General

7. Lowe's

13. Walgreen's

15. TJX

 

There is something about retail (insert past performance caveat here) that allows for long periods of sustainable growth even though retailing is very competitive and the moats are squishy at best. Part of it is the simple growth formula of SSS + store openings. Operating leverage probably plays a role too.

 

Obviously, retail is a terrible business. But there are a few select companies that can unlock a sustainable growth formula. I think Ulta is one of them and I think the current pessimism will create a tremendous buying opportunity. I currently have a 2.5% starter position but hoping for further weakness.

 

 

Are you able to identify any common threads among the very successful retailers that you can use to identify potential winning retailers that are still early in their growth phase?  In other words, is there an underlying common business model or characteristic(s) that produces the SSS + store growth that, in turn, produces great returns on capital? 

 

To me, the list suggests some possibilities:

 

1.  Initial efficiency (from better logistics, management, etc.) leading to a permanent lower cost structure via economies of scale (Walmart, Lowe's, Home Depot, Costco, Dollar General)

 

2.  A better method of sourcing products that can be used at scale (Costco, Dollar General, TJX). 

 

3.  Getting people in the door via a necessary, likely low-margin item (gas/prescriptions/new car) and then getting them to buy other stuff while they're there (Couche-Tard, CVS(?), Walgreens(?), car dealerships)

 

I don't know enough about Tractor Supply to have any sense of whether it is similar to any of the above.  Lululemon is a brand that controls its own retail distribution via vertical integration, so I wouldn't group it with the other retailers, i.e., companies whose primary business is distributing other companies' products to consumers.

 

Also, given that retailing is a distribution business, you have to determine which historical examples are still relevant given the changes to distribution caused by the internet.

[DooDiligence]

I've gone into the Ulta in my town twice over the past 2 weeks.

 

The store was very busy & had a line at checkout on both visits.

 

They have multiple sections in the store where a stylist will help with applying different products.

They also have areas where products can be sampled without someone breathing down the customers neck.

 

The salon in the back of the store had clients in all the chairs who were having their hair done.

 

I've talked to the young ladies in class about where they get their beauty products & why they get them there.

The consensus is that there's loyalty to particular brands but not to any 1 outlet.

 

The complaints about Ulta were that they spam the crap out of you when you sign up for the loyalty program (natch).

I showed them how to find the unsubscribe button in an email, which was kind of funny, a 57 yo man schooling millennials on tech.

The upshot is, they like shopping there because of the selection & ability to sample & get instruction on product use & the pricing is OK.

 

Both visits, I left with the impression that this is a business with sustainability as long as they keep executing.

I do, however, feel that there are not too many barriers to entry other than scale.

 

I'm not sure how they initially attract someone into the store but can see how once a customer is aware of Ulta,

it becomes a reliable supplier of the brands a woman wants & a great source of discovering new ones.

 

You just can't beat product demonstrations.

 

That said, Dillards & all the big box stores have makeup counters which will do the same.

 

I think there's a segment which will become loyal to the stylists themselves more than the stores.

[Cigarbutt]

1-Good work KCLarkin. You correctly identified the sentiment overreach versus a fundamental and material deterioration. However, the numbers (lower sales growth, lower sales growth especially in the high margin category, lower sss growth) are IMO starting to define a new trajectory that will be discovered over time. The challenge is to discount the value of this trajectory without taking into account the separate amount of the subjective premium or discount that may be attributed to such trajectory. The point: forgetting the recent price convulsions, the market continues to be relatively optimistic about the ULTA's prospects. ULTA has done very well and adapts well to the new normal (lower capex in supply chain, slower geographic expansion) but retail is tough and the future value is related to future resilience, ie the challenge will continue.

 

2-The question KJP is asking is very relevant. Retail winners can be exceptional in the sense that returns can be fantastic but also in the sense that it's an unlikely outcome. I guess it's a case by case analysis. Let's make a parallel with Costco (another winner). Costco shares some characteristics (moat maintained despite online threat, relatively mature stage reached in the US, forward returns may come from international expansion). They also share their membership program which is a big plus. Costco has been able to earn great returns, in large part, because the revenues (and the loyalty) derived from the member card allowed them to accept lower operating margins, contributing to the perception of the value of the products and increased asset turnover. For Ulta, the membership's value has more to do with loyalty only but the program appears to be well run and explains a lot of the recurrence from customers. Costco, through various differentiating and enduring features, has been able to build value for specific customer segments and has been able to resist the online threat (so far). I think ULTA's main differentiating operating feature (apart from both prestige and mass appeal) has been the in-store presence of a services offering. The store concept and geographical footprint would be very hard to replicate. Below is a link that I found very useful for Costco and that helps to define how a retailer can build, maintain and even increase market share in an enduring way. A similar comparative exercise could be done for other winners that KJP mentions.

https://issuu.com/slowappreciation/docs/costco_deck

 

3-On the international expansion front, I have an opinion that is somewhat limited and anecdotal. I owned stock in a Canada-based pharmacy a while back. The chain had been privately founded and became public in the late 80's. The company was an example of a resilient retail winner. The great idea of the founder (in the 1960's) was to combine a pharmacy with a discount store, with the pharmacy situated at the back end of the store, allowing people to load up with stuff that they otherwise would have bought elsewhere. They did great but competitors came with a similar layout. The reason I invested in the 1990's was, among a few other reasons, because the franchised pharmacy chain had developed a beauty concept with a strategic localization and layout in their physical stores and that component became a significant profit driver. During the holding period (and also since then to a certain extent), I (anecdotally to some degree) compared how Canadian pharmacy chains had evolved vs CVS and Walgreens. Even if US pharmacies did well with the beauty and cosmetics segment, I always felt that CDN pharmacies did better in terms of their ability to capture a larger swath of the market. This is a reason why I think ULTA may have a relatively harder time with its footprint in Canada. The competitive landscape includes players in the mass market and the prestige categories but the main actor is Shoppers Drugmart and I would say that it may do a better job than CVS and Walgreen, both in terms of its present offering and its capacity to adapt to potential entrants.

https://www.retail-insider.com/retail-insider/2019/7/makeup-monopoly-a-look-at-ulta-beautys-canadian-competitors

http://strategyonline.ca/2019/08/12/shoppers-drug-mart-launches-the-beauty-project/

 

@DooDiligence

Thank you for the scuttlebutt work. :)

I don't have a natural inclination to connect with retailers but some people in my household explained to me how hanging out in some brick-and-mortar stores can make sense after an online connection of some sort (you should spend 2 minutes and watch some of those cosmetics youtube videos).

[Spekulatius]

What also helps ULTA is malls and department stores dying, imo. The department store entrance was a main area with high foot traffic where beauty products were demonstrated and sold. These areas now have way less foot traffic and the department stores itself are hurting, which even hurts the categories that have been healthy for them, opening the door to competitors with a sharp focus like ULTA.

 

Maybe that’s obvious, but I think ULTA (and Sephora) have secular tailwinds as long as Department stores keep withering away.

[kab60]

A bit "old" but pretty good summary of the industry and challenges - as well as opportunities: https://www.cnbc.com/2019/12/27/how-department-stores-lost-their-clout-in-the-beauty-industry.html?__source=twitter%7Cmain

[HalfMeasure]

Anyone have a good feel for the worst case scenario here amidst COVID?

[Cigarbutt]

Anyone have a good feel for the worst case scenario here amidst COVID?

Assuming that the long term fundamentals are intact (moat etc), let's assume also three years of no earnings (which can be discounted to now, to about 30$ per share) and a PE of 15 on last year's earnings (about 12$ per share): 150=180-30

I guess this is a reasonable starting point for valuation. Things look bleak and may look bleaker but it is reasonable to assume that customers will eventually make up with the physical stores.

[MarioP]

Since we don’t know how long the stores will be closed nobody can know. The hard base is the online sell of the last quarter. But it will be interesting to see which % of the stores sell will transfert online. It will be a good clue of the loyalty to the brand.

[KCLarkin]

I doubled my position today. Market is already pricing in prolonged store closures and a major recession. Ulta is net cash, so it can survive a brief depression.

[Guest roark33]

The operating leverage on retailers can be brutal, also, one thought is that people who are still wearing make-up (my wife hasn't the past week because she has barely left the house), might develop an online shopping habit. 

 

I like the company and the stock, just thinking out loud regarding the negatives.