ULTA's Beauty Is Skin Deep
Jonathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The way ULTA's (NASDAQ: ULTA) stock is behaving, you'd think the company was the next IKEA, except for beauty products. But ULTA is really more like a hybrid of Regis Corporation's salons (NYSE: RGS) , Limited Brands' Bath & Body Works (NYSE: LTD), Sally Beauty Supply (NYSE: SBH), and even pharmacy chains such as CVS (NYSE: CVS). It's a beauty supply store plus a salon, with aisles of drugstore and prestige cosmetics to boot. It's a well-executed concept that marries prestige with affordability, a winning formula in the crowded beauty marketplace.
As privately owned Coty Inc.'s philosophy brand puts it, beauty retailers sell hope in a jar. ULTA understands this industry tenet and has managed to create a pleasing, moderately upscale ambiance that is within the reach of the suburban middle-class consumer. The company does away with much of the "service" associated with cosmetics counters in department stores; in its stores, there are no salespeople bearing spray bottles of perfume who ambush you at the door and you pick products off the shelves yourself. Instead, you are free to buy your entire beauty regimen in one go. After browsing the aisles and mixing and matching brands from different price points, you go pay at a centralized checkout. On the way, you can treat yourself to a full array of salon services ranging from manicures to facials.
With its blend of convenience and accessibility that doesn't skimp on the pampering, this experience is a game changer, especially compared to the counters at the typical department store, and it's why ULTA has been characterized as disruptive, a buzzword usually reserved for the latest social media startup in Silicon Valley. It's also why ULTA's market cap of $6.19 billion and forward P/E of 30 dwarf those of its rivals.
ULTA's success has largely been predicated on its rivals' lack of innovation. Regis salons haven't changed much over the years, continuing to focus on basic hair services and having made little headway selling hair care products. Their limited inventories feel stale like afterthoughts. Making matters worse, the salons are stuck in enclosed malls, which are hardly the first place you'd think of heading for a haircut and which lack the convenience of the super-regional power strip malls ULTA favors. Bath & Body Works is another mall-focused chain. It relies more on private-label merchandise than ULTA does (only about seven percent of ULTA's sales are ULTA-brand products) and accordingly, lacks ULTA's selection of name brands.
Other rivals are capable of competing in terms of convenience. Alas, Sally Beauty Supply operates small, cramped, uninspiring stores. And pharmacies don't exude the aura of indulgence and pampering that customers want, although they are making inroads on ULTA's turf by employing beauty advisors, stocking more expensive products, and offering loyalty programs similar to ULTA's.
ULTA's a 22-year old company with an exciting growth proposition. But at the end of the day, all the hype is over a place to buy Oil of Olay and get your nails done. It isn't that difficult for ULTA's rivals to copy its merchandising or to emulate its pricing strategy, which consists of abundant 20% off and $3.50 off $10 purchase coupons in the mail and in the Sunday papers. For example, CVS now stocks premium beauty products in well-lit displays, and the chain is promoting its ExtraCare Beauty Club that offers $5 rewards for every $50 spent on beauty products.
The other main issue is ULTA's limited pricing power. Many of its entry-level products have been commoditized and are subject to heavy discounting elsewhere, and ULTA isn't immune from competition at the premium end of the spectrum either. Like department stores, ULTA might not discount prestige brands, but it does have to compete in terms of service, atmosphere, and occasional gifts with purchase. In Sephora and many department stores, it has worthy rivals. As ULTA moves upscale, expect some resistance from prestige brand consumers, who may find that other chains convey a stronger sense of luxury through greater staffing and locations in tony downtown districts largely devoid of ULTA stores.
The Bottom Line
ULTA has an alluring story, but it can't bathe in the fountain of youth forever. In the face of fierce, relentless competition, the novelty of its modern stores will fade away, and its feverish rate of growth will slow. If, like me, you don't hold ULTA shares and want to avoid investments with the potential to cause frown lines, I'd stay away. But if you've been fortunate enough to enjoy the run-up in the stock price, consider taking some money off the table. Go ahead and treat yourself to a service at the ULTA Salon and some products from the front end of the store. Then, look for companies that have unsung value, those with beauty that is more than skin deep.
Fool blogger Jonathan Lim has no positions in the stocks mentioned above. The Motley Fool owns shares of Regis. Motley Fool newsletter services recommend Ulta Salon, Cosmetics & Fragrance. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.