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Ulta Beauty Gains on Omnichannel Strength Despite Cost Woes

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Ulta Beauty, Inc. (ULTA - Free Report) has been taking strong measures to augment sales through its solid omnichannel strategy, impressive loyalty programs and efforts to boost offerings. These upsides have helped this Zacks Rank #3 (Hold) stock rally almost 13% in the past three months, outpacing the industry’s growth of 2.5%.

However, Ulta Beauty has been grappling with rising selling, general and administrative (SG&A) expenses, which is a threat to its operating margin. Also, soft makeup sales in the U.S. beauty market is a worry. Let’s delve deeper.



Factors Favoring Ulta Beauty

Ulta Beauty has been focusing on striking the right balance between online and physical stores, which has been helping this leading beauty retailer increase both e-commerce and in-store sales. Notably, the company’s store-to-door strategy has been yielding results. It is also seeing growth in the usage of buy online and pick up in store facilities. Moreover, the company is enhancing its mobile application capabilities.

Backed by such endeavors, the company continued to witness online traffic growth in the third quarter of fiscal 2019. Apart from this, the company is on track to reach its goal of 2-day e-commerce shipping by 2021. Such moves are likely to help create a seamless digital shopping experience for Ulta Beauty’s customers. Markedly, management projects e-commerce sales growth of 20-30% for fiscal 2019.

Ulta Beauty’s loyalty program has also been a key business driver. In the third quarter of fiscal 2019, the program attained 33.9 million active members. Moreover, sales from loyalty program members continued to represent more than 95% of the company’s total revenues and reflect a rise in average spend per member. This growth was fueled by the company’s excellent marketing and merchandising endeavors. Additionally, the credit card program has been yielding well and contributed to the top line in the fiscal third quarter. Strength in the loyalty program will likely continue owing to the addition of brands, maturation of loyalty members and higher penetration of the credit card program.

These upsides, together with the company’s focus on innovation and expansion of distribution network, bode well.

Hurdles

Ulta Beauty has been struggling with rising SG&A expenses for a while. A rise of 140 bps in SG&A expenses, as a percentage of sales, led to an 80-bp contraction in the operating margin during the third quarter. Further, the company expects an operating margin deleverage of 60-70 bps for fiscal 2019. The company’s expenses are usually allocated toward increasing store labor and greater spending on growth initiatives and innovation. Additionally, higher cost of investments toward digital channels, salon services, infrastructure, personalization efforts, brands and initiatives to enhance customer experience may result in increased corporate overheads.

Apart from this, challenges in the U.S. beauty market due to the soft makeup business are a concern. Well, the makeup business has witnessed several up and down cycles in the United States. The most recent downside started in 2017 and accelerated in late 2018 as a result of a lack of innovation and newer products. This trend continued through 2019, especially in the third quarter.

Management expects this cyclical trend to persist, which we believe might hurt the company’s performance.

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