ULTA - Ulta Beauty

[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.

[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.