One of the stickiest businesses that is often recession proof is the beauty business. Consumers tend to spend a high share of their personal income on skin care, hair care products and makeup in good times and bad.
The largest domestic specialty retailer of beauty supplies is Ulta Beauty Inc. (ULTA, Financial) with approximately 1,350 retail stores as well as 355 Ulta Beauty mini-stores within select Target Corp. (TGT, Financial) locations. Ulta offers an extensive range of beauty products and services, including cosmetics, skin care, fragrances, hair care and salon services. The stores are known for their one-stop shopping experience and wide assortment of products at all price points.
The products fall in six main categories: cosmetics is the largest with 42% of total net sales, beauty products and hair styling tools with 21% of total net sales, skin care with 17% of total net sales, fragrances and bath are 14% of total net sales and services, its smallest category, was 3% of total net sales.
Addressable market
The size of the beauty market is large and continues to grow. It is highly fragmented with many small players. The company estimates the market to be at $104 billion and is growing in the 2% to 3% range. Skin care is the largest subsegment with approximately 23% of the addressable market, with cosmetics being the second-largest at 17% and hair care coming in third at 15%. The distribution of beauty supplies is highly diverse with the maturity of sales going through online or grocery store avenues with specialty stores like Ulta and Sally Beauty Supply (SBH, Financial) representing about 15% of the distribution sources.
The target consumer for the company is the so-called “beauty enthusiast,” which is described as a person who is obsessed with everything new and noteworthy in cosmetics, hair and skin care. The beauty enthusiast represents about 83% of the company's beauty products revenues and two-thirds of shoppers at the stores.
Ulta has competitive advantages in terms of a broad product offering consisting of skin care, hair care, cosmetics, fragrances and services such as hair styling and makeup applications. Price points range from inexpensive to high-end luxury products. The Target in-store Ulta locations have a also been important from a total customer acquisition perspective.
Financial review
The company has an enviable record of same-store sales growth. Excluding the 2020 Covid-19-driven sales decline, same-store sales growth over the past four years have been 15.60%, 37.90% (Covid-19 rebound), 5%, and 8.10%. Earnings pers share has more than doubled from $10.94 in 2018 to $24.01 in 2022. Skin care products continues to be strong with double-digit growth while hair care was up mid single-digits and makeup grew at low-single-digit rates.
For the second quarter of 2023, organic growth also continued at 8% and total sales increased 10.10%, which was driven by three net new store openings.
Gross profit increased 7.10% to $994 million in the second quarter, but gross margins decreased to 39.3% compared to 40.4% in the prior-year period. This was driven by higher shrink, increased supply chains costs and low product margins.
Also during the quarter, the company repurchased 593,629 shares of common stock at a cost of $275.5 million. As of July 29, $541.0 million remained available under a $2 billion share repurchase program first announced back in March of 2022.
Cash and cash equivalents were $388.6 million, and the company has no traditional long-term debt. The inventory position appears to be in good shape as merchandise inventories increased 9% to $1.82 billion compared to $1.67 billion at the end of the second quarter of 2022. The inventory increase was primarily due to higher sales demand, 37 net new stores, product cost increases and new brand launches.
In a statement, CEO Dave Kimbell said, “The beauty category has continued to deliver healthy growth, as consumers maintain their post-pandemic routines and expand their definition of beauty. Our proven business model, diverse assortment, best-in-class loyalty program, and outstanding teams have enabled us to deliver stronger-than expected results for the first half of fiscal 2023, and I remain confident we can deliver against our updated expectations for the rest of the year.”
Valuation outlook and guru interest
Due to a strong track record of growth, Ulta has typically carried high valuation metrics. Price-earnings ratios have typically been in the 30 to 40 times range over the past 10 years. The stock has declined 21% year to date and is selling near 52-week lows. Currently the stock is selling at roughly 15 times 2023 earnings estimates with an enterprise value/Ebitda ratio of 10.
Using the GuruFocus discounted cash flow calculator to double check whether the company is undervalued creates a value of $421 when using current earnings estimates of $25.43 and a 10-year growth rate of 8%. The actual 10-year growth rate for the company has been almost double that.
Wall Street analysts still seem to be enamored with the Ulta story with 12 buy ratings and five hold ratings. The average price target $523, or 40% higher than the current stock price.
The GF Value indicator also shows an undervalued situation based on multiple metrics.
Overall, Wall Street investors have also been adding to their positions with recent guru buys from John Hussman (Trades, Portfolio), Ken Fisher (Trades, Portfolio) and Jim Simons (Trades, Portfolio)' Renaissance Technologies.
Summary
Although the company could see some near-term headwinds from inflation and lower consumer demand due to the high consumer debt levels, the stock still appears to be undervalued and represent an opportunity for long-term investors.
As new beauty trends emerge over time, the company should be able to maintain its strong track record of growth going forward.
