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NASDAQ: ULTAJake Biedronski

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The beauty & cosmetics industry has a glowing future: Consumers trends are continuing away from buying makeup at

department or drugstores and towards one-stop-shops. Overall consumer spending in the US and disposable income available

to women in the US are both rising. The rise of selfies and constant photo-taking has led many women to

have makeup available at any time. Brick-and-mortar is still the key for this industry, as consumers like the

ability to try out products and receive employee opinions.

Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ: ULTA) positions itself as one of these single-stop retailers where all beauty needs can be addressed.

The Idea

What Does the Industry Look Like?

A few major players leading the way, but a lot of competition.

The industry is primed for growth. Although competition is high,

barriers to entry do exist, limiting new entrants’ success.

Strong US dollar will benefit consumers as many products are imported from overseas vendors.

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Market Opportunity People just aren’t shopping at department stores as

much any more Women used to shop for makeup either at a department store on the

high end, or a drugstore/discount store on the low end. One-stop-shops like Ulta are the trend. Ulta has a 19.3% market share with room to grow.

International Expansion Ulta has not expanded internationally yet, and certainly could take

advantage of this opportunity in the future. There is potential for expansion in Europe, Latin America and China,

which could allow the company to continue its extraordinary growth.

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Retail ($3.5 billion – 21.1% increase) Beauty, cosmetic and related products. Includes both outside brands and Ulta’s private label collection.

Salon ($209.2 million – 19.2% increase). Salon, nail and skin care services. “Brow Bar” for eyebrow waxing/plucking.

E-Commerce ($221.1 million – 47.5% increase) Currently only represents a small portion of total sales (about 6%). Considerable growth in this part of the industry across the board and

has been a focus for Ulta. Management envisions e-commerce to generate 10% of sales in the

near future.

How Do They Make Money?

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Cost of Goods Sold (70% of Expenses) Beauty Products, Makeup, etc. Distribution Costs Salon Expenses

Other Operating Expenses (24.5% of Expenses) SG&A Pre-Opening Costs (only about 0.5%)

Income Tax Expense (5.5% of Expenses)

How Do They Spend Money?

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Where Does ULTA Excel? In addition to growing revenue and earnings substantially in

the past 5 years, ULTA has also been able to creep up its margins all while returning excellent amounts on equity.

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Doing More With More Ulta’s main strategy for growth has been increasing its store

count from about 400 in 2010 to almost 900 now. As a growing and attractive brand, Ulta has been able to

negotiate favorable leasing rates from landlords who want to see the company in their strip malls and power centers.

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Doing More With the Same Same store sales growth

was slowing, but new initiatives like a revitalized Ultamate rewards program have picked up the pace.

Q1 2016 numbers suggest that the recovery has stayed strong, pushing same store sales growth even higher.

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Same Store Sales Growth

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The Ultamate Rewards program was revitalized in 2014 and expanded to include all purchases.

Had 18 million members end of FY 2015 (Jan. 2016). Now up to 19.4 million members and still growing.

Ultamate Rewards members are visiting more frequently and spending more per visit, contributing about 80% of total sales.

Rewards, Rewards, Rewards

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The company’s private label brands, collectively “The Ulta Beauty Collection” represent an area for higher margin growth.

Currently only 6% of total sales, so some cannibalization would not be a bad thing if it means higher margins.

Management has a strong focus on developing Ulta’s private label brands and expanding their percentage of sales

Take It Private

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CEO/Director Mary Dillon: Served in position since 07/2013, Served in executive positions with US Cellular, McDonald’s, Quaker Foods, and others. Strong experience turning around brands.

CFO/Treasurer Scott Settersten: Joined in 01/2005 from over 15 years with PwC.

Chief Marketing Officer David Kimbell: Joined 02/2014, worked with Mary Dillon at US Cellular.

Management

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Cap IQ long term growth of 20% propelled by ~66% retention rate Currently no dividend, but share buybacks are a part of their strategy Net income has been positive and growing for many years Online sales currently represent 6% of sales with management set on

increasing this to 10% Company has no long-term debt and only a single revolving line-of-credit Executives are now paid primarily in equity with performance bonuses

based on achieving revenue (33%) and EBT (67%) targets. PE multiple of about 45x is fairly expensive compared to the market, but

doesn’t look so bad when considering Ulta’s superior growth.

Understanding Future Worth

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Competition

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Macro Trends: Ulta and other beauty retailers are definitely impacted by economic downturns, so a recession would certainly be bad for business.

CCC: The company is starting to get paid less often, with a climbing Cash Conversion Cycle number.

E-commerce: Ulta is trying to be a bigger player here, but brick-and-mortar is certainly the company’s expertise. Better strategy from players like Estee Lauder or even Amazon could threaten growth in this area.

Saturation: Growth is great and looks good for investors too, but how many stores is too many? Ulta has begun dialing back new store expansion, but has long term plans to operate 1200 stores in the US. Only time will tell whether the timing is too late (or possibly even too soon).

Risks

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Management is driven and incentivized to produce significant returns for shareholders.

Ulta has demonstrated its ability to grow organically, even limited only within the United States.

As more women work and earn higher incomes, the demand for beauty products will continue to trend upward.

A strong rewards program is driving sales higher within the existing customer base.

3-Stage FCFE Valuation is fairly in-line with current price at $246, but also uses fairly conservative assumptions.

A pullback to 35-40x earnings would be optimal, but I would still consider buying at the present price.

Bottom Line For Investors

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“‘Everything has beauty, but not everyone sees it.”

- Confucius