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Will the lipstick effect make Ulta Beauty a good investment?

Opdateret: aug. 22



We might be facing economic headwinds in the near future, which is why I will be looking into companies that have the possibility to thrive in this environment. One of such companies is Ulta Beauty, which is already in my portfolio.


This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.


Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.


Prior to investing in Ulta Beauty, I had no personal experience with the company. It is a company that operates only in North America and in a business I didn't know much about previously. I was made aware of Ulta Beauty as it was mentioned several times in the Phil Town workshop I attended. Because of that, I decided to look further into the company in order to see if it would be a good investment, in what I believe, will be the economic environment we will be facing shortly.


Ulta Beauty is a company that was founded in Illinois in 1990 and now have stores all over the United States, where they have developed a strong brand moat with their 1.264 stores scattered across all of the states in the US. Their market cap is $17.96 Billion, meaning it is a large player among sellers of beauty products. They sell products from all the well-known brands but also have their own brand. Besides selling various products, their stores are also equipped with a salon. We will go further into their growth potential later but let us just go through the management and the big five numbers we always go through.


Their CEO is Mary Dillon. She has 35 years of experience leading consumer-driven brands such as McDonalds and PepsiCo prior to arriving at Ulta Beauty. Since she became the CEO in 2013, she has more than doubled Ulta Beauty's revenue. In 2019 she was on the Barron's list of the World's Best CEOs. She also serves on the Board of Directors for Starbucks and KKR, Inc. Besides that she is the Chairperson for the Retail Industry Leaders Association and a member of The Business Council. She says that she has a passion for leveraging consumer insights and are leading through the lends of culture to build brand engagement and drive results. NB Mary Dillon will be stepping down as CEOthe 2nd of June 2021, where she will become executive chair on the board of directors. She will be replaced by Dave Kimbell, the current president of Ulta Beauty.

We have determined that Ulta Beauty has a brand moat. We really do like the current management as well. Now let us look into the big five numbers in order to see if Ulta Beauty does live up to our requirements for a strong moat. In case you want an explanation about what the big five numbers are, you can have a look at "MY STRATEGY" on the website.


The first number we will look into is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all of the benchmarks. Up until last year Ulta Beauty shows fantastic numbers. I wouldn't put too much important in the last year, as Ulta Beauty was significantly hit by the pandemic.



The next numbers we will look into are the Sales Growth Rates. As we can see the Sales Growth Rate is well above 10 %. It is not exactly what we would like to see but excluding the numbers from last year, they are far from alarming, and wouldn't be something that would keep me from investing in Ulta Beauty. Like in all the other numbers, we can discard the one year benchmark.



The next numbers are the EPS Growth Rates. As with all other growth rates we want the numbers to be above 10 % in all benchmarks. Not exactly what you would like to see, when looking into a company. While it shouldn't exclude you from investing in a company (obviously, as the company is in my portfolio), it will be something you will need to be aware of.



The Equity Growth Rate is the most important of the four growth rates. And while it could certainly be better, it is nice to see that it performs positively in all of the benchmark, ,even the one from last year. These numbers are encouraging.



Finally we look into the Cash Growth Rates. Remember that we just discard the one year benchmark, as it is not representative for a company such as Ulta Beauty. The other numbers do look good, despite the 3 year benchmark being underwhelming.



To shortly summarize the five numbers from Ulta Beauty. We can completely discard the numbers in the one year benchmark. Their business was impacted by temporary store closures and they were unable to offer skin and makeup services for almost the entire year. Yes, there are some slight concerns with the EPS growth rate, while the other three growth rates: Sales, Equity and Cash look acceptable. Most importantly though is that the ROIC looks good, and it will always be the most important number when looking into a business to invest in.


Another important thing to look into is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by current cash flow. Due how the pandemic has affected the business of Ulta Beauty, they needed to obtain some debt, which can be paid off in 9,1 years. However, it is based on their underwhelming results in 2021, where their net sales decreased by 16,8 %. Meaning, it isn't something I'm worried about for the time being as the U.S. is starting to open up again.


Before I calculate a price I want to pay for Ulta Beauty, I will look into potential growth and risks that Ulta Beauty is facing.


It is estimated that the beauty product industry is worth $92 billion, and Ulta Beauty only has a 7 % share of that. I also mentioned that Ulta Beauty has a salon in each of their store, it is believed that the salon service industry is worth $58 billion and Ulta Beauty has less than 1 % of that share. These figures show that there are plenty of room for Ulta Beauty to grow in both the beauty product industry and the salon service industry, and their own research indicates that they continue to increase their market shares across the categories. Another interesting growth opportunity for Ulta Beauty is partnerships. Together with Target Corporation they have developed a shop.in-shop concept that will offer an assortment of brands online, as well as in 100 Target locations in the beginning of the second half on 2021 (with plans to scale it to hundreds more over time).


As with all companies Ulta Beauty also faces some risk. The most obvious one is the Covid-19 pandemic, which lead Ulta Beauty to close their stores in 2020. Luckily, it seems like the U.S. is opening, and with the rollout of the vaccine, it is unlikely that we will see another lockdown. However, if we do, it will definitely be a blow to Ulta Beauty, despite them improving their e-commerce. Even without another lockdown the pandemic could still interfere with the salon business in Ulta Beauty. The pandemic will eventually disappear but Ulta Beauty is also facing other risks. Data suggests that cosmetics industry in the US market declined in 2019 and once again in 2020 compared to previously years, and even though Ulta Beauty is aware of this and still believe they can grow, it is certainly a risk to be aware of. Another risk to be aware of is they only have exposure to the US market, as their expansion into Canada was not successful, and being limited to only one market might slow down growth.


If you follow me on eToro, you would know that I'm a bit concerned about the economic environment we are facing. And you might wonder why I did not mention this as a risk for Ulta Beauty. I actually think it might strengthen Ulta Beauty if we go into recession or recession like times, and it is due to what I mentioned in my headline called the lipstick effect. The lipstick effect is a theory that when facing a economic crisis consumers are more willing to buy less costly luxury goods. Researchers from Texas Christian University published a research in the Journal of Personality and Social Psychology that a downturn in the economy has been linked to an upswing in beauty sales since the Great Depression.


All right, we have gone through the numbers, potential and risk regarding Ulta Beauty, and now it is time for us to calculate a price for Ulta Beauty. In order to calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. Due to the uncertainty of whole situation with the Covid-19 pandemic I decided not to use the current EPS, instead I decided to use a EPS of 10, which is much higher than the currently but is lower than the ones on 2018 and 2019. Estimated future EPS growth rate of 12 (Which is also a bit conservative based on estimates), Estimated future PE 24 (in this case we multiply our predicted growth rate with two, as this is lower than the historical highest P/E) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $184,325, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Ulta Beauty at price of $92,13 (or lower obviously), if we use the Margin of Safety price.


Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". In order to do so, we need some numbers from their financials, keep in mind that all numbers are in millions. The operating Cash Flow last year was 810,36. The Capital Expenditures was 151,87, however once I studied their annual report I saw that it was only 96 of those that was used on maintenance, which is why we use that number. The Tax Provision was 55,25. We have 55,39 outstanding shares. Hence, the calculation will be like this: (1810,36 - 96 + 55,25) / 55,39 x 10 = $138,94 in TEN CAP price.


The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 10.92 and a growth rate of 12 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $150,43.


I do believe that Ulta Beauty is a great company with a great (current) management. Even though they are facing some risks, I see the company as having a great growth potential. If we are facing economic headwinds, I believe that Ulta Beauty will perform quite well due to the lipstick effect, and if we do not see a recession, they also seem to do very well, as we have seen over the last 10 years. I will most definitely open a position in Ulta Beauty if it hit my PAYBACK TIME price of $150,43. (I should mention that I opened a position based on the 2019 numbers, where the TEN CAP price was $204, if Ulta Beauty falls to that price, you may consider how much the pandemic will actually affect future results).


My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how to do it, you can read this post.


I hope that you enjoyed my analysis. Unfortunately I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me instead or check out my portfolio every now and then.


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