Ulta Beauty Could Be a Winner In 2022

The macroeconomic outlook is turning favorable

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Jan 25, 2022
Summary
  • The company reported strong earnings for the 3rd quarter of 2021, aided by improving consumer sentiment.
  • Ulta Beauty boosted its full-year guidance after taking into account the strong momentum seen in the market for beauty products
  • There is a risk of profit margin contraction due to the intensifying competition in the industry.
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Founded in 1990 and based in Bolingbrook, Illinois, Ulta Beauty, Inc. (ULTA, Financial) is the largest specialized beauty retailer in the U.S. with approximately 1,300 stores. Its vendor base includes The Estee Lauder Companies Inc. (EL, Financial), L’Oréal and Shiseido, and the company sells more than 25,000 products from around 500 well-established and emerging beauty brands across all categories and price points. Makeup products account for the majority of its sales, and these products include fragrances, skincare, haircare, bath and body items. The company also offers private-label products.

While the reopening of the economy has been a positive development for most companies, Ulta in particular appears to be thriving. Not only are makeup and beauty products selling better as people are getting out of the house more, Ulta has also gained even more of a competitive edge due to its financial strength, which helped it weather the pandemic better than peers.

Latest earnings recap

As of the writing of this article, Ulta's most recent earnings results were for the third quarter of 2021. Net sales increased 28.6% to $2 billion in the third quarter. The company reported a 16.8% increase in transactions and a 7.7% increase in average ticket value. Even compared to the third quarter of 2019, comparable sales increased by 14.3%, which suggests Ulta Beauty has grown even beyond pre-pandemic levels.

Driven by the solid revenue growth and ongoing cost optimization efforts, gross profit improved from $545.5 million to $789.5 million and operating income advanced to $284.2 million. The adjusted operating income for the third quarter came to $124.9 million, and diluted earnings per share increased to $3.94 compared to $1.32 in the comparable quarter of the previous year.

Staying true to the company’s commitment to rewarding shareholders, Ulta Beauty bought back shares worth $126.4 million in the third quarter and aims for share buybacks of nearly $850 million for full-year 2021.

The omnichannel focus is working well

While consumer confidence improved, Ulta Beauty’s focus on strengthening the omnichannel experience between online and physical stores also helped fuel the stellar financial performance in the last quarter. The company made several efforts to enrich its omnichannel experience, including the introduction of Beauty to Go, collaborating with DoorDash, Inc. (DASH, Financial) to roll out same-day delivery in several states, launching two unique salon services across all stores, relaunching skin services in certain stores and launching Ulta Beauty at Target Corporation (TGT, Financial) across 92 stores and online.

The company has already achieved the fiscal year target of opening more than 100 Target shop-in-shops, and this was possible because of the better-than-expected recovery of the U.S. economy, according to the earnings release. The rebound of sales, however, did not come without costs for the company. As the company increased its marketing efforts, operating margins came under pressure as a result of an uptick in selling, general and administrative expenses.

Among the major beauty categories, skincare stands out the most in terms of growth, backed by serums, cleansers and moisturizers, as modern-day consumers become increasingly concerned with skin health. Embracing this trend, Ulta Beauty will cut unproductive stock-keeping units and reshuffle the format for new and renovated stores to push the skincare assortment to the front.

The strong performance from the e-commerce segment was fueled by the buy online, pick up in-store orders, which rose 28% year-over-year. To cater to online shopping, which is becoming increasingly popular, the company is focused on expanding capacity at fulfillment centers, expanding shipping capabilities and introducing curbside pickups. The company’s online app with virtual try-on options saw a surge in popularity in the last couple of years, and Ulta Beauty is focused on improving this value-adding feature further in the coming years.

The long-term outlook is promising, but there are risks

Ulta Beauty boosted its full-year guidance after taking into account the strong momentum seen in the market for beauty products in the first nine months of 2021. The company also guided for higher operating margins driven by an expansion in gross margins, which is expected to result from fixed cost leverage, better merchandise margins, lower salon costs and reduced headwinds related to channel shift.

Looking at the longer-term financial targets set by the company, Ulta Beauty expects total net sales growth of 5% to 7% on a compound annual growth rate basis from 2022 through 2024. Over the same period, the company expects to open 50 new stores each year.

The U.S. beauty market has been struggling with soft makeup sales trends, which remains a concern for Ulta Beauty. There is also stiff competition in the industry, which includes a diverse group of retailers such as department stores, mass merchandisers, specialty retailers, drug stores, high-end and discount salon chains, locally owned beauty retailers and pure-play e-commerce companies. The majority of these competitors have financial resources to seize opportunities in the beauty industry, which makes it a necessity to invest in marketing to retain brand value. For this reason, Ulta Beauty’s profit margins may come under pressure in the next few years.

Takeaway

The first nine months of 2021 proved to be good for Ulta Beauty and its shareholders, and the company is likely to build on this momentum in 2022 as well. The increasing volatility in global stock markets might weigh on the company's stock in the short run, and so could the high costs of marketing to retain brand value, but long-term-oriented investors who are intersted in this stock may consider this volatility as an opportunity to get in at a lower cost if they expect strong earnings growth in the next five or so years.

Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure