An increasingly digitally-focused business model may improve the financial outlook of Ulta Beauty Inc. (ULTA, Financial). The cosmetics retailer is seeking to increase customer engagement through investing in its mobile app and artificial intelligence.
It is also planning to expand internationally, while improving the efficiency of its supply chain.
Although the stock has climbed 45% over the last year versus a gain of 8% for the S&P 500, Ulta's prospects suggest it has investment appeal.
Investing in digital opportunities
Investments in the company’s omnichannel shopping experience could strengthen its competitive position. For example, in the most recent quarter, its store-to-door service, where store associates assist customers in ordering products when they are unavailable in store, recorded demand growth of 20%. Demand for the company’s buy online, pickup in store offering has also increased following its operation in 47 stores. The service is expected to be rolled out to all of its locations, investing in the functionality of its website to make the ordering process easier.
Ulta is also focusing on its mobile app. Changes include an improved order history view to make reordering easier, as well as improved usability of the Glam Lab live try-on function that is being rolled out for Android users.
Artificial intelligence is expected to become a key part of the company’s sales process, and could differentiate its offering from peers. It launched the skincare virtual beauty advisor on its website in the most recent quarter. The feature asks dynamically-generated questions to present a set of personalized recommendations for online customers. The service works alongside the in-store digital stylist that is being tested in six stores. It allows staff members in the company’s salons to show possibilities to customers in terms of makeup, hair color and eyebrow shaping.
Efficiency
Ulta is aiming to improve customer service levels and loyalty through increasing the efficiency of its supply chain. As part of this initiative, the company is implementing a strategy that seeks to improve fill rates through close collaboration with brand partners. So far, this has led to a 200 basis point improvement in fill rates since being implemented in the third quarter of 2018.
Further efficiency improvements are expected to take place as Ulta Beauty’s Fresno distribution center ramps up, with it now serving 245 stores and fulfilling 22% of online orders. The conversion of its Romeoville distribution center into an e-commerce fast fulfillment center that can process up to 30,000 orders per day is on track to open in the current quarter. This is expected to contribute to the company achieving its goal of two-day shipping by 2021.
Threats
Ulta's performance in the most recent quarter was mixed as its prestige cosmetics segment continued to experience soft market conditions. It would be unsurprising for the wider business to face an uncertain period due to a weak retail sales environment. With tariffs potentially being increased on a wide range of Chinese imports, consumers' disposable incomes could be squeezed. This may negatively impact demand even for those products that are not subject to tariffs since they may become less affordable to many consumers who experience price increases elsewhere.
The company’s plan to expand internationally could lead to an increasingly diverse business model that is less reliant on one specific market. It is poised to enter the Canadian market and has a strong pipeline of new products, particularly in the prestige cosmetics segment, that are expected to catalyze its performance in the current year and beyond.
Outlook
Ulta Beauty is projected to post 13% earnings per share growth in the current year, followed by a further gain of 16% next year. This helps to justify its price-earnings ratio of 29 and suggests it may offer fair value for money given its long-term growth potential.
The investments it is making in its digital offerings could differentiate it from peers and produce a higher degree of customer loyalty.
Increased efficiency and international expansion may also create a stronger business that is better placed to cope with an uncertain wider retail environment.
Even though Ulta has outperformed the S&P 500 by 53% in the last year, further growth could be ahead.
Disclosure: The author has no positions in any stocks mentioned.
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