Ulta Salon, Cosmetics & Fragrance, Inc. (ULTA): The Ultimate Beauty Solution

While reviewing Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA), the constant realization is that the company has no comparable competition. The beauty sector is a massive industry yet the majority of the products are sold via direct marketers, department stores, or drug stores. Neither group offers a focused, easy to visit store format. For a consumer that wants quality products, they previously had to travel to a distant mall. Enter Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA) into the mix and clearly investors have been excited about the historical growth rates.

Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA)

The genius of Ulta is the lack of directly focused competition, especially for investment dollars. Sure investors can chose direct marketer Avon Products, Inc. (NYSE:AVP) or professional beauty supplier Sally Beauty Holdings, Inc. (NYSE:SBH). In neither case do investors get a stock with a direct competitive threat to Ulta or even stocks with any meaningful growth potential these days.

Flat stock

The stock action of Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA) over the last year highlights the major point of paying the right price for a stock. Ulta recently reported that Q1 2013 revenue surged 22.9%. These gains came from both strong comparable sales of nearly 7% and growth in square footage. Unfortunately for investors, the stock was priced for perfection as the spring of 2012 rolled along.

Adding Prestige brands

A major catalyst for the rest of the year will be the addition of the prestige brands of Clinique and Lancôme in boutiques within the stores. These premium brands will help drive the high-end customers to Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA) that typically went to a Sephora store at a J.C. Penney Company, Inc. (NYSE:JCP) or a Macy’s.

Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA) expects to add a total of 125 stores for the year with the majority added during the rest of 2013. The store base reached 576 stores at the end of Q1, helping square footage grow 24% year-over-year. More importantly, the company added eight Clinique boutiques to reach 51 and plans to add 25 Lancôme boutiques this year. These boutiques are expected to drive more high-end customers to the stores.

Competitive threats

Sally Beauty Holdings, Inc. (NYSE:SBH) probably has the most comparable concept with a vast retail network. The company, though, focuses more on the professional market with a skew towards salons. In that light, Sally Beauty Holdings, Inc. (NYSE:SBH) isn’t as much a direct competitor, yet it does have over 4,500 retail stores, suggesting that Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA) might be able to expand on the goal of reaching 1,200 retail locations. Unfortunately Sally only has a market cap of $5.2 billion with a revenue base of $3.6 billion. The stock trades at a solid multiple of nearly 20 times current year earnings estimates, a sign to investors that a massive store base doesn’t always equal larger valuations.

Avon Products, Inc. (NYSE:AVP) is more of a direct competitor as it manufactures and markets beauty products through direct selling and independent representatives. With revenue of over $10 billion, it is definitely a target for Ulta to take market share. Instead of dealing with a friend that resells Avon Products, Inc. (NYSE:AVP), the hopes are that Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA) will provide a more convenient and appealing option. The vast selection at Ulta, including the new Clinique and Lancôme boutiques, hopefully pulls consumers from the historical direct marketing model.

Like most in the general sector, Avon is facing flat to declining growth. The stock has a substantial market value of over $10 billion and only trades at 1 times revenue due to the lack of growth. Surprisingly, analysts see earnings surging over the next few years, allowing the stock to trade at over 16 times next year’s estimates. The stock appears expensive considering the lack of revenue growth.

Bottom line

Amazingly, Ulta Beauty appears to offer the ultimate beauty shopping solution for a massively fragmented market. From department stores to drug stores to a direct seller such as Avon Products, the market has a vast amount of retail outlets that sell beauty products such as makeup, yet Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA) is one of few with quality products situated outside of mall locations. What woman wants to trek out to the mall for a $15 beauty product that can be easily purchased at a more convenient non-mall location on the way home from work?

At 23 times forward earnings, Ulta now provides an entry point equivalent with its growth rate. Historically that valuation level has provided great entry points for fast growing companies.

The article The Ultimate Beauty Solution originally appeared on Fool.com and is written by Mark Holder.

Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool recommends Ulta Salon, Cosmetics & Fragrance. The Motley Fool owns shares of Ulta Salon, Cosmetics & Fragrance.

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