How Ulta Beauty Inc Stands Out From the Crowd

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In this segment from Industry Focus: Consumer Goods, the team dives into the ongoing success of Ulta Beauty (NASDAQ: ULTA). Thanks to customer favorites such as its Ultamate Rewards program, promotions, and salon services, the company has withstood the pressure of e-commerce, while other retailers call it quits. 

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A full transcript follows the video.

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This podcast was recorded on June 27, 2017.   

Vincent Shen: Ulta is a specialty retailer. I consider them very much so, in terms of strength in their business model, similar to TJX (NYSE: TJX), though they probably have more of an online presence that you will discuss, Addie. Can you give us a quick rundown of what they do? Then we'll dive into some of the bright spots for them as well.

Addie Lalier: Yeah, absolutely. Ulta is the largest beauty retailer in United States right now, and it offers cosmetics, fragrance, skin-care products, hair-care products, and full-service salons in their stores. They currently operate 990 stores in 48 states and are located primarily in strip malls in suburban areas. Along with their physical store presence, Ulta has a strong online presence, as well as a downloadable app. In the last 12 months, Ulta sales increased 23.7% to $4.9 billion.

Shen: Very nice. Our interns have actually been pitching stocks on a weekly basis as an ongoing project. Ulta was a company that you actually covered last week, Addie. I'll let you take the reins here in terms of, what do you think are the main things -- for TJX it was the evolving inventory that they offer, the discounts, that value, and the feelings that shoppers get when they go into one of their stores. What is it that Ulta offers to its customers that has allowed them to really outperform as well?

Lalier: I think there are two main things that really drive Ulta ahead of everyone else. One is their physical stores and how it feels to go into that store, and the layout, and how it's open, and the staff is friendly, and there's so much selection, and there's the salons, and there's a placement of the services such as the Brow Bar, that's at the front of the store -- I think when you really go in there, everything is so easy to navigate. Whether you're looking for one thing, you end up finding other things. It's really the layout of the store. And I think that other stores don't really have that as strong as Ulta does. Another huge thing is the loyalty rewards program. It's called the Ultamate Rewards program. It's pretty much one point for every $1 you spend. The more points you get, you get a monetary reward. So the next time you buy something, you get X amount of dollars off the more you accumulate. I really think that drives people and is an incentive to buy more. And they're super guest-centric, their business model, whether it's the loyalty system, and there's coupons in the advertisements. I think overall, they really focus on the customer relationship, and wanting them to come into the stores, and rewarding them for doing so.

Shen: Sure. And it's not just the feeling, in terms of the layout. While that is all very conducive to that positive shopping experience, these benefits of their layout, of offering some services in addition to the products, and also the loyalty program, they have a quantified effect on the business. From what I've seen, some of the loyalty program members, similar to other programs that we've seen, in terms of companies like Starbucks, for example, they tend to be much better customers. How does that end up panning out for the company?

Lalier: Absolutely. Sales from loyalty members actually accounted for about 90% of their revenue. Which is huge, yeah. That speaks for itself that this program is working, and customers are really appreciative of the rewards they're getting. Another big part of Ulta is their salon service, which is huge, and no other beauty retailers really have that. That really differentiates them. Actually, salon guests spend almost three times as much as non-salon guests, and shop two times more than non-salon guests. That's a huge metric in terms of what they're doing for their customers and how much they're spending.

Shen: That, frankly, reminds me of a lot of these different concept stores that certain other retailers have been trying, in terms of that you need to offer something beyond just what you're selling to bring people in the door, and when you do, it becomes more of an experience for the seller. Everybody's talking about how especially younger consumers are looking for more of experiential spending rather than material spending. And I can see how, this is the kind of thing that, somebody can come in for their salon services, and while they're walking out, potentially browse for the various cosmetic products, things along those lines, and walk out with, in this case, what was it, three times bigger ticket size, right?

Lalier: Yeah.

Shen: Beyond their stores, they also do have a bigger digital presence than TJX, who we were talking about previously. Can you elaborate a little bit on what some of those efforts look like?

Lalier: Right. They have a huge e-commerce presence. Along with that, they also have a downloadable app where you can do the same things that you would do online. So you can shop, you can see your rewards. There's actually a thing called the Glam Lab where you can test out products. Which, in terms of other retailers selling products online, I think this is where Ulta has a competitive advantage, because when it comes to beauty products, you want to be able to smell it and try it and everything. Customers can do that at Ulta in stores. But then, also, that transfers over to, they can go home and order it online. Whereas, other companies, such as Amazon, you can't get that same experience. So I think they really hit all channels, whether it's through the app, through the online sales, or in store, they're super omni-channel, and I think customers flow through all three of those pretty frequently.

Shen: Sure. I'm sorry, I don't understand for this Glam Lab thing. Is that a digital way of trying things on? How would that even work?

Lalier: Yes. You upload a selfie of yourself, and you can try on different makeup. I know.

Shen: That's impressive. Following a similar line of thinking with our TJX discussion, there is a lot of competition in this industry. You have other big names in cosmetics and makeup like a place like Sephora. I guess the question becomes, the growth rate that Ulta has been seeing so far, do you guys view that as being something they're going to be able to sustain longer-term? What is, essentially, the moat for this company?

Lalier: I think they're completely sustainable. They're penetrating the U.S. market really strongly right now, but their e-commerce presence is huge. I think they can transfer over to that at any time, and they really want to grow that as well.

Sarah Priestley: Yeah, I think the online business grew 56% last year. That is just astronomical when you compare it to other retailers. A lot of people are going to be enviable of that. So they obviously have cracked the omnichannel. I do think it's a lot down to the experience and the fact that they are value-driven, too, because you're going to risk the Amazon, the Best Buy issue, that people are going to go into one of these stores and try to make up, and if they can get it cheaper elsewhere online, they may do that.

Shen: Yeah, showrooming. That was a huge issue for some of these big box stores. I am curious, if they benefit from a similar situation, with TJX, it was the ticket size. I know that cosmetics can get very expensive, but I'm curious sometimes if it isn't just more convenient, once you're there and you've tried it and you like it, then you just want to take it home with you?

Priestley: It's instant gratification.

Shen: That can even beat a one- or two-day shipping offer from someone like Amazon. My last point that I would like to discuss is what some bearish investors might be looking out for, or people who are concerned in terms of potential headwinds for the company. What are things that you guys are watching that you think our listeners should also keep an eye on, despite how well the company has been doing?

Lalier: I think when people think of Ulta and any beauty retailer, their minds jump to Sephora. And I think Sephora is probably the closest competitor to Ulta. But I think they're very different. Sephora is chic and sleek. I think the overall business model is a lot different. Sephora is located in malls and large cities, while Ulta is more spread out and vibrant and located in more suburban areas, strip malls. They're targeting some different people there. But one of the biggest differences between the two, touching back to the loyalty program, is this different rewards system that they have going on, and how much Ulta focuses on its customers a little more so than Sephora. I think that's the one thing that's really putting them in front of them. And to go into some details on that, Ulta does the monetary reward program, where it's a point for $1. Sephora is more samples. You get sample rewards, or free shipping on orders X amount or more. I think it's really the monetary side of it or samples. And I just really think Ulta is one step ahead of Sephora by offering this huge variety of coupons and exclusive offerings in the point system.

Shen: So despite the competition there, they have a leg up in terms of offering that stronger incentive.

Priestley: It's going to be interesting to see, as they expand into urban areas -- I know that's what they're starting to do now, into urban areas, and the places where Sephora is, people are going to be faced with a choice. They sell a lot of the same brands, and especially now, they're starting the MAC boutiques, which, am I right, Sephora doesn't offer those?

Lalier: Correct.

Priestley: So to me, they're going to be duking it out.

Lalier: It's going to be exciting to watch, yeah.

Sarah Priestley has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Starbucks, and Ulta Beauty, Inc.. The Motley Fool recommends The TJX Companies. The Motley Fool has a disclosure policy.