The Digital Age

It wasn't that long ago that it seemed everyone was nervous about brick-and-mortar retail going away for good, to be replaced for all time by online commerce. The ease of buying online--you don't have to leave your house! You don't have to wade through crowds of people!--seemed to present an existential threat to physical retailers.

Of course, these fears were overblown. Amazon (AMZN), often hailed as the physical store killer-in-chief, has certainly changed the landscape, forcing competitors such as Target (TGT) and Walmart (WMT) to roll out their own digital, delivery, and curbside pickup options in response.

But then there were certain types of products that never quite seemed in total danger from e-commerce--in this category, beauty products led the way. Today we'll cover beauty retailer Ulta (NASDAQ:ULTA), and whether we think investors should consider it for their portfolio.

The Business

Founded in 1990, Ulta currently operates a little more than 1,350 stores across the United States and carries roughly 25,000 SKUs from over 600 brands in its inventory. The premise of Ulta is simple: people, largely women, want to purchase beauty products but do not usually want to do so sight unseen. Further, buying beauty products in yesteryear could require multiple visits to multiple departments stores which, aside from salons in some cases, were the principal beauty product retailers of the day.

Condensing a wide array of brands and price points across a large physical space staffed with consultants who can assist shoppers in finding the right product for them, then, seems on its face like a winning proposition. Add in a streamlined e-commerce channel so guests can re-purchase items they like in the store along with a generous loyalty program, and you, as they, have yourself a winner.

Of course, it isn't all that simple. The beauty industry is notoriously cutthroat, but management at Ulta has navigated its challenges well. The company has even expanded its footprint from standalone stores and taken a bit of a cue from the former department store giants and their beauty counters by opening Ulta Beauty shop-in-shops at more than 350 Target locations nationwide.

The market, for what it's worth, seems to be on board with Ulta's business strategy as well. Over the last ten years Ulta stock has appreciated more than 500%, compared with a 160% increase in the S&P 500 (SPY).

The revenue mix has been relatively stable over the years, with cosmetics consistently making up more than 40% of sales, followed by haircare and styling, with the high-margin fragrance and bath business taking up about 14% of annual sales.

Growth And Projections

Aside from a dip in 2021, Ulta's revenue and operating income trends are likely to bring a tear to investor's eyes.

Of course, investors don't often buy stocks based on how they've performed in the past. Expectations of future cash flows are what we want to know about.

This is one of the major worries in the market today. As interest rates remain high and seem set to rise even further, profits across many industries are set to be squeezed. It was recently reported that analysts across Wall Street were slashing estimated earnings at a faster clip than normal in trying economic times.

It's heartening, then, to see that Ulta's estimated FY2025 earnings per share continues to climb even against this difficult macroeconomic backdrop.

Valuations

So far, we've done a brief overview of Ulta's business, it's past revenue and some of Its future earnings potential. This is all well and good, but the thought may be growing in the back of your head, saying "all this sounds great--I bet it's wildly overvalued."

Taking a look at Ulta's historic forward EV/EBITDA tells us that, at least compared to the average, this is not the case.

Over the past ten years, Ulta has traded at an average multiple of 14.2x forward EV/EBITDA estimates. Today, ULTA stock trades at a slight discount to this historic norm at 12.1x.

The stock also changes hands at a discount to its historic ten-year forward price-to-earnings average. Today the stock trades about 20x next year's earnings, which is well below the ten-year 27x average.

If the valuations above seem too high for you even now, then consider that the beauty is largely considered recession proof. That statement, of course, is only true as long as the market is willing to believe it, but there is reason to believe that--based on previous tough economic times--the beauty industry is indeed quite resilient.

Risks

Principal risks to our bullish outlook are a deeper than expected recession which would cause consumers to downgrade or delay purchases from Ulta. A second would be reputation risk--if the company were to find itself embroiled in some sort of social media or culture war-type debacle, sales would almost certainly suffer to a degree.

Putting It All Together

We believe that no one metric should be considered in a vacuum when making an investment decision. A company can have fantastic earnings forecasts, but be wildly overpriced, for example.

In this case, we feel that Ulta has multiple things working in its favor. It operates in a largely resilient industry, its valuation (on both a forward EV/EBITDA and price to earnings) seems reasonable on a historical basis, and management has thus far executed on its growth strategy well.

For these reasons, we believe that investors should give consideration about whether Ulta deserves a place in their portfolio.