5 Things Ulta Salon Management Wants You to Know

By Billy Duberstein Markets Fool.com

Ulta Salon (NASDAQ: ULTA) continues to post blockbuster numbers and dominate the beauty category. This is a rare bricks-and-mortar retailer that has made a name for itself in the age of Amazon (NASDAQ: AMZN), and growth investors should take note.

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On March 9, Ulta posted its fourth-quarter and full-year 2016 results (financial year ends in January). For the full year, the company grew revenues 23.7% on 15.2% comps, which was an acceleration from the mere 11.8% the year before. These are pretty stunning results, especially when you consider the rut in the general retail environment. Earnings per share grew a whopping 30.9% for the year, as expanded operating margins and share repurchases provided further tailwinds.

Still, the stock initially sold off after-hours on somewhat conservative guidance of (only!) 8%-10% comps growth in 2017 and low-20s EPS growth, which would be a big deceleration from the past year.

The next day, though, the stock rebounded to new highs, as a good jobs report, combined with investors digesting the conference call, provided optimism that the company can beat guidance and continue its incredible run of earnings beats and raises. Here are some of the reasons investors continue to believe in Ulta.

Image source: Getty Images.

Ulta knows what its customers crave -- newness and enthusiasm

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Ulta prides itself on being a destination for "beauty enthusiasts,"and this focus works very well with Ulta's business model. By bringing prestige and discount brands, along with salon products and services all under one roof, Ulta can always have something new and different going on. This makes it a go-to destination for consumers who are into cosmetics and beauty products.

Moreover, beauty enthusiasts are more likely to spread Ulta's gospel via word-of-mouth. Malcom Gladwell called these enthusiasts "mavens" in his book Tipping Point, and they are pivotal characters that play a large role in kick-starting big, disruptive trends in society.Basically, if you want to start a big trend, start by impressing those who are passionate about the subject.

The company's studies show that 57% of beauty shoppers are "enthusiasts," so it's not as if we are talking about a small sliver of the population.CEO Mary Dillon estimates the company only has 20% of the "beauty enthusiast" population out there, so despite the company's robust growth in the past couple of years and its near 1,000 store count, there is still plenty of room to take market share.

The "secret sauce" of the loyalty program

Many people know of the Pareto principle called the "80-20" rule, which is that a business typically gets 80% of its revenue from only 20% of its customers. As such, Ulta Salon garners a majority of its sales from members in its loyalty program. Loyalty members garner points when they buy Ulta products, and they can rack up discounts, which Ulta can customize with its advanced analytics. This makes Ulta's program a very strong "moat," keeping customers in its ecosystem, rather than going to, say, Amazon for repeat purchases. CEO Dillon even called it the company's "secret sauce" on the last earnings call.

In 2016, the company actually increased its loyalty members by 5.2 million members for the full year. That was an increase of 28%, bringing the total to 23.4 million customers. Despite that impressive percentage increase, loyalty members grew at a slower rate than overall customers and that certainly bodes well for Ulta's future.

Moreover, the company rolled out an Ulta Beauty credit card this past year, whereby customers can earn points even when not buying from Ulta. This expansion of the loyalty program could serve to deepen customer loyalty to Ulta stores.

Online and omnichannel

Despite e-commerce sales being lower margin than in-store, Ulta has aggressively gone after online. The company is resolved to meet its customer wherever and whenever they want.Online sales grew 56.2% and added 240 basis points to the full-year comp. Online margins did improve, and the company is investing in faster delivery times and a better online experience. CEO Mary Dillon said:

... we study this closely, we look very closely at consumer, at our guest trends and the guests who are shopping online only this is a small number of people it's really about guest who are shopping in-store and online and that guests who is involved across both channels is really driving 2.5 times more sales really, it's not somebody who is just buying in-store. ... So, even if that margin is I think in some ways inherently going to be somewhat lower than bricks and mortar, it's a very incremental business to us.

Going forward, Ulta will invest in distribution center expansion and add a new facility in Fresno this year, speeding up times to west-coast customers.

MAC partnership is a big deal

One of the bigger news items coming out of the call was a new agreement with MAC makeup. For those who aren't familiar, MAC is the No. 1 prestige brand in the country, and typically, it can only be found at its own MAC stores, or in select department stores. With the decline in department-store traffic, though, and with Ulta on the rise as a beauty destination, the companies reached an agreement whereby Ulta will roll out MAC boutiques inside 100 of Ulta's stores by the end of the year.

MAC cannot be found at competitors like Sephora, so this is a big deal.Aside from attracting new interest and customers, the deal should validate Ulta in the eyes of the industry as the hottest place to shop for makeup.

Ulta goes urban

Finally, it may be surprising for people to know that despite being a nearly $18 billion company, Ulta does not have a presence in Manhattan. That's because Ulta typically builds stores in suburban power centers and strip malls.This has been a sweet spot that allows it to pay reasonable rents, while also steering clear of traditional mall locations, which have been hit incredibly hard because of the growth of e-commerce.

This, year, though, the company will be opening up its first location in Manhattan, along with other more urban locations such as Michigan Avenue in Chicago and the Mall of America in Minnesota. These locations require higher capital expenditures and higher rents and labor, but Ulta feels it has the brand strength to take on urban America at this point.

Going forward, it looks as if Ulta is firing on all cylinders. The stock is by no means cheap -- it trades at almost 44 times trailing earnings -- however, given its growth rate, expanding margins, and investments from a position of strength, I would not be surprised to see Ulta continue to dominate the makeup space in the years ahead.

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Billy Duberstein owns shares of Amazon and Ulta Salon, Cosmetics and Fragrance. The Motley Fool owns shares of and recommends Amazon and Ulta Salon, Cosmetics and Fragrance. The Motley Fool has a disclosure policy.