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Holly LaFon
Holly LaFon
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David Rolfe Comments on Ulta Beauty

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October 12, 2018 | About:
We initiated a position in Ulta Beauty (NASDAQ:ULTA) during the quarter. Ulta is one of the largest beauty retailers in the U.S., typically located in off-mall spaces. For several quarters, the company reported comparable store sales numbers that seemed to defy the general retail space and at the same time seemed unsustainable over the long term. The Company was growing much stronger than peers in both top line sales and bottom-line earnings, with the former running at a strong double-digit rate. Valuation levels of Ulta started to come in around mid-2017 as comps were beginning to slow from the peak mid-teens. However, the Company continued to put up strong sales growth and management was sticking to their +20% earnings growth target through 2018. Current comparable store sales are running in the high single-digits, still much better than their peer group. Ulta is expanding their digital footprint and investing in their e-commerce business, which has now risen to 10% of total company sales (a year ahead of target), allowing them to compete and grow in the all-important online space.


Ulta has a small share of the $138 billion market for beauty products and services in the U.S. While this market has seen steady growth of low single-digits in mass cosmetics and mid-to-high single-digits in the prestige beauty space, Ulta is reporting bottom line growth in the 20% range, which means they are gradually capturing market share from their peers. Their store growth model currently targets 1,400 to 1,700 stores over the next several years, which would result in store base growth in the high single-digit to low double-digit range as they open approximately 100 stores on average per year. Having ended the most recent quarter with just over 1100 stores, this leaves years to their store growth model alone.


The company’s target customer is the “beauty enthusiast,” a segment of shoppers that is the most engaged in the category with high expectations for their shopping experience. They represent 57% of women and 77% of spend in the category, crossing all aspects of demographics, age, race, and ethnicity. Ulta believes their share of beauty enthusiasts is 30%, which leaves plenty of room to capture a larger share of this group. Ulta also has a loyalty program which consists of nearly 30 million members as of the end of the most recently reported quarter. The program has shown strong member retention and 90% of total company sales come from loyalty members. These members tend to shop more frequently as well as spend more than nonmembers. Ulta, in addition, is working to increase shopper engagement. Only 10% of loyalty members are shopping both online and in store. As Ulta converts these shoppers to a more omni-channel guest, they have found that their transaction spend increases dramatically - nearly 3X.


The purchase of Ulta brought the third retail name into the portfolio, but business-model overlap between the trio is de minimis. Ross Stores has limited health and beauty offerings and of course dominates the off-price apparel space. Tractor Supply caters to the niche rural lifestyle. And as we have done with the two other retail names (and really every holding in the portfolio), we also determined Amazon’s threat to the Ulta model. The perceived risk is that Amazon will crush all existing brick-and-mortar retail stores. However, we are seeing digitally native brands partner with Ulta to enhance their distribution through brick-and-mortar offerings (e.g. Colourpop, Morphe, and the most recently announced partnership with Kylie Cosmetics). In addition, Amazon health and beauty offerings tend to be more health and wellness replenishment items. Individuals are not likely to experiment with new brands without being able to test color, formula, etc., and this is where we believe the brick-and-mortar store offers a clear advantage to an online only offering.


For these reasons, we believe Ulta provides a well-diversified addition to the portfolio with plenty of room for growth, which we were able to add at reasonable valuation relative to historical figures.



From David Rolfe (Trades, Portfolio)'s Wedgewood Partners 3rd quarter 2018 shareholder commentary.

About the author:

Holly LaFon
I'm a financial journalist with a master of science in journalism from Medill at Northwestern University.

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