Ulta Magnificence: The Arrival In Mexico Got here At The Finest Time (NASDAQ:ULTA)

Investment Thesis

After a nearly 30% drop, Ulta (NASDAQ:ULTA) is trading at 15 times earnings. This may not seem like a bargain to some of you, but considering the quality of the business and the opportunity for expansion in Mexico, which will begin next 2025 and would be arriving just after growth appears to be slowing, I think it is an investment option that should be taken into account.

Outstanding Business

Ulta operates beauty and personal care products stores. In their stores they sell beauty products such as makeup, skin care products, fragrances, hair products and beauty tools. Although most of its sales are from other well-known brands, it also has its own line of beauty products that sometimes releases products that go viral and are an extra source of income.

This market is very large, the company estimates that it is just over $110 billion, which considering the sales of $11 billion that Ulta generated in 2023, means that despite being a leader in the sector, it would have close to 10% market share.

Sales for beauty products tend to be recurring, which has benefited the loyalty of Ulta customers. Currently, a large part of the company’s sales are made by members of its loyalty program, which, although not entirely representative, since the company itself encourages you to join its program when paying, it does provide the company with insights about its customers to project trends and be more efficient managing its inventories.

The company has had a great performance on the stock market historically thanks to the fact that its income and earnings per share have grown year after year and except for 2020, sales have increased in all these years, including 2009 and 2010, which shows us how good and predictable which is usually the business.

Since 2013, revenue has grown 15.5% annually while EBITDA has grown 16% thanks to the slight margin expansion it has presented.

Another proof of the company’s good business is its return on invested capital, which has consistently remained superior to other retailers that sell third-party products, such as Foot Locker or Dick’s. This shows us a business that has the ability to obtain a lot of value from its investments, which in the case of Ulta is usually purely in more stores, since the company doesn’t usually make acquisitions.

The company has been reducing its debt year after year, and currently it represents only 0.5 times EBITDA, so in that aspect there is no risk of financial problems either.

Mexico? Just About Time

One of the most important news that we could hear from the last earnings call was the officialization of a plan to enter Mexico. This is something that, as a Mexican-American, I didn’t understand why Ulta didn’t start it sooner, since in Mexico there is no a national competitor that has monopolized the beauty market and that was something that Sephora (OTCPK:LVMHF) has been taking advantage in recent years.

Today, we are excited to announce our planned market entry into Mexico. The Mexican beauty market is sizable, growing, and has significant beauty opportunity.

CEO Dave Kimbell during Q4 2023 Earnings Call.

Sephora began its foray into the Mexican market in 2022 with 5 stores and currently expects to reach 100 stores in the next 6 years. The Mexican beauty market is promising due to its size of one third of the American population, a fairly similar consumer style and the lack of a competitor to consolidate it, so it was time for Ulta to start making a presence in this region and would like to hear something about Canada too.

After extensive evaluation, we prioritized an asset light partnership approach to enable us to move quickly. And I am excited to announce we have formed a joint venture with Axo, a highly experienced operator of global brands to launch and operate Ulta Beauty in Mexico in 2025.

CEO Dave Kimbell during Q4 2023 Earnings Call.

To achieve this, the company will be using a franchise model, according to what Mr. Kimbell implied, working together with Grupo Axo, which was founded in 1994 and currently has experience exporting more than 30 brands throughout Latin America in countries like Mexico, Uruguay, Chile or Peru.

Some of the brands that have exported are Bath & Body Works, Hollister or Victoria’s Secret, so it makes sense that Ulta has decided on this group to start its expansion. The financial implications remain to be seen, but it seems like a smart plan.

The Main Competitor

Following in Sephora’s footsteps seems very important to me, since lately the brand owned by LVMH has been gaining market share very significantly. A few years ago, Ulta’s Google searches were much higher than Sephora’s, but today they compete shoulder-to-shoulder.

In addition, this year Sephora already surpassed Ulta in number of stores in the United States and according to Spring 2024 Piper Sandler research, Sephora was the most named Top Beauty Destination with 37%, when just a year before Ulta had obtained 41% of mentions in this same survey.

In Mexico, although there is some awareness of the existence of Ulta, the difference with Sephora’s is gigantic, reinforcing the idea that the company must do something if it wants to continue growing, since according to the latest report for Q4 2023, seems that growth in the United States is no longer what it was a few years ago.

In the last quarter, the company had Comparable Sales growth of just 2.5% year-over-year. Furthermore, the guidance for this year is not much better either, expecting a growth of approximately 5%, that is, $11.7 billion to $11.8 billion in revenue.

Valuation

The company has historically grown 15% annually over the last decade, although as we saw, this growth appears to be lower by FY2024. So, if we were to put ourselves in a very negative scenario in which the company only grows 5% annually in the next 5 years and the profit margin remains similar to the current one, I would still expect a return close to 15% annually assuming that the P/E paid out of 20.

Many will doubt that a P/E of 20 is fair, but in my opinion, even if Ulta became a low-growth company, it is still operating a very stable business and beyond Sephora, it has no real competitors. If we consider that in recent years it has become a cannibal company, buying back between 3 and 5% of its shares annually, paying a little more would be justified in my opinion.

For my specific estimate, I considered buybacks of 4% annually based on recent years when during 2022 5.65% of shares were repurchased (that’s a lot), since the company doesn’t have as many capital allocation options due to its controlled debt and large footprint in the U.S. and international expansion will be carried out with franchises, which don’t require a high initial investment.

In the last 10 years, shares have decreased at rates of 3% annually. Last year they repurchased $1 billion in stocks and for 2024 they approved a buyback plan of $2 billion more, so these will be an important factor of return for shareholders in the coming years, in my opinion, since if earnings don’t grow as much in the coming years, buybacks will help boost EPS.

Second, having essentially completed the authorization announced in March 2022, today we announced a new share repurchase authorization for $2 billion.

Paula Oyibo, Senior Vice President at Q4 2023 Earnings Call

Risks

You would think that a geographic expansion would be a major risk, as it requires a lot of investment and could go wrong. But in the case of Ulta, management made it clear that this would be in an asset light manner, which dramatically reduces any risk and makes it an asymmetric investment for the company.

What does seem like a risk to me is the competition with Sephora, which has made things very difficult lately and although the market is very fragmented, continuing to lose popularity compared to Sephora would harm sales as well.

The Bottom Line

The company has fallen almost 30% from its last high, which is partly justified by the market’s disappointment with this year’s guidance. And while it seems like growth is slowing, I think that based on the P/E of 15, the power of share buybacks and the opportunity for international expansion, at the current price the company looks like an appealing buy.

For the quarterly results on March 30, we arrived with quite low expectations. Revenue is expected to increase just under 4% year-over-year and an 8% decline in EPS. I don’t think there are going to be big surprises, but if there were, I think they would be positive. In any case, the current valuation is low enough so that if it disappoints a little, the shares will not plummet so much.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.