Consumer Discretionary

Chad de Gannes

November 22nd, 2016

Tear Sheet

Investment Case

The Investment Case for Ulta can be summarized as follows:

Competitive Advantage: First and foremost, Ulta is the largest Beauty retailer in the U.S. They have expanded their company’s store growth to approximately 900 stores around the country. Their stores have a wide range of beauty cosmetics products to haircare, skincare and salon styling tools. At the end of August 2016, Proactiv announced Ulta as their first national retail partner, which opens up Ulta to a larger segment of customers who can now purchase the proactive products at their stores. Aside from selling a variety of beauty products, Ulta also offers private label products consisting of Ulta branded cosmetics, skincare, bath and body products.

Opportunities: Ulta has many long term growth opportunities to increase revenue each year and continue to expand their customer segments. Ulta has currently 900 stores but has begun expansion to store locations of between 1400-1700 by the year 2019. Ulta also has a growing customer base of more than twenty million members which are a part of the Ultamate Rewards Program. Also, Alliance Data Systems Corp. has signed a long-term agreement with Ulta, to provide private label and co-branded credit card services. These branded credit cards are intended to enhance customer experience of Ultamate rewards program.

Long-Term Growth: For the past five years, Ulta has had unprecedented growth of 120%, so 24% of revenue growth each year. Revenues peaked at $3.92 billion in the year 2015. Ulta’s long-term 5-year growth stands at a great average annual rate of 19.5%. Ulta’s CEO Mary Dillon plans to double its current market share of 4% of the beauty market within the next few years. The beauty market is worth $127 billion. The Ultamate Rewards Program will be the key driver in terms of long-term growth since it accounts for approximately 90% of Ulta’s sales. The company's marketing campaign is also contributing to Ulta's successful comp store sales growth. The campaign includes radio, TV, digital advertising and in-store promotions. Results of Ulta's survey showed that aided brand awareness increased 84% vs. 77% a year ago. The advertising is bringing in new customers and reigniting older customers who haven't shopped at Ulta recently. So, the company is effectively marketing itself, which is likely to help drive future growth.

Segmentation: Within the next few years, Ulta is targeting three main segments, Millennials, Latinas and Teenagers. The projected income for the Millennial group is approximately $8.3 trillion by 2025 due to the fact this group shops 32% more than the average customer. Also, this group is more mobile and technology friendly so with improvements to Ulta’s mobile site, they will be able to raise revenues when infiltrating this segment. The Latina group is a growing segment within the U.S., where they currently occupy 17% of the population. This group shops 34% more than the average customer. For the teenager segment, 87% enjoy to shop in the store for beauty products

due to the excitement of having the option of being able to buy products. These are the three segments which Ulta will move its focus to in the next few years.

Valuation: Ulta does trade with an above average forward P/E of 44.2 as compared to the Specialty Retail Industry's P/E of 20.87. I would expect the stock of a company with above average top line and bottom line growth to trade at an above average valuation. Ulta's PEG, which takes the 5-year expected EPS growth into consideration, is reasonable at 1.7 as compared to the S&P 500's PEG of about 2.8. Ulta has the advantage of being a one-stop shop for salon services and cosmetics. Overall, I think that Ulta is trading at a reasonable fair valuation considering its strong growth rate.

Company Overview

Ulta Salon, Cosmetics & Fragrance, Inc. operates as a specialty retailer in the United States. Its stores provide cosmetics, fragrance, haircare, skincare, bath and body products, and salon styling tools. Further, the company offers private label products consisting of Ulta branded cosmetics, skincare, bath and body products, and haircare products; and other health and beauty products. About a third of its locations are in Illinois, Texas, Florida, and California. Ulta stocks more than 20,000 prestige and mass-market products. The company’s full-service salon offers hair, skin, and brow services; and provides products through its Website, ulta.com. Ulta Salon, Cosmetics & Fragrance, Inc. was founded in 1990 and is based in Bolingbrook, Illinois. The company’s CEo is Mary N. Dillon and has been the CEO since June 2013. Their ticker is ULTA and ULTA is traded on the NASDAQ stock exchange.

Ulta has experienced unprecedented growth over the years, with revenues peaking at $3.92 billion in 2015, a company milestone. The historic growth for 2015 was primarily fueled by a spike in salon service sales due to the opening of 100 net new stores sales during the year. Profits also surged to a record-setting $320 million in 2015 as a result of the additional revenue coupled with a spike in interest income, resulting from short-term investments with maturities. After steadily growing the last several years, cash flow from operations dipped by 5%, mainly due to changes in working capital in merchandise inventories, due to the opening of the new stores.

Ulta believes that their focus is on delivering a compelling value proposition to our guests across all of our product categories drives customer loyalty. They offer a comprehensive loyalty program, Ultamate Rewards, and targeted promotions through our Customer Relationship Management (CRM) platform. They also offer frequent promotions and coupons, in store events and gifts with purchase.

Their stores are predominantly located in convenient, high-traffic locations such as power centers. A typical store is approximately 10,000 square feet, including approximately 950 square feet dedicated to our full-service salon. The store design, fixtures and open layout provide the flexibility to respond to consumer trends and changes in our merchandising strategy. As of October 29, 2016 Ulta Beauty operates 949 retail stores across 48 states and the District of Columbia and also distributes its products through its website, which includes a collection of tips, tutorials and social content.

Financial Analysis

Liquidity Ratios

Analyzing Ulta Salon’s financials, one can notice that its Total Revenue growth over the prior year, has grown at 22.1, indicating more sales had occurred for the period of January, 2016 than the previous year. The company has increased its sales and net income during the past fiscal year. Net income has increased by $62.9 million over the past year and also sales have increased by $682.7 million. Ulta’s current Quick Ratio stands at 0.91 for the quarter ending July 2016. It indicates that the company cannot currently fully pay back its current liabilities. During the past 13 years, Ulta Salon Cosmetics & Fragrance Inc.'s highest Quick Ratio was 2.04. The lowest was 0.27. And the median was 1.05.

This graph shows how Ulta stacks up against some of its competitors in the industry in terms of Quick Ratio to Markey Cap. You can clearly see that Ulta is in the middle of the graph in terms of their Market Cap, but on the higher spectrum of the Quick Ratio compared to other companies while maintaining above the industry median (0.84) for the Quick Ratio. ULTA's Quick Ratio is ranked higher than 54% of the 902 Companies in the Global Specialty Retail industry.

Ulta Salon Cosmetics & Fragrance Inc.'s current ratio for the quarter that ended in July 2016 was 2.80. It is ranked higher than 79% of the 902 Companies in the Global Specialty Retail industry. This is a very acceptable ratio and indicates that Ulta has good short-term financial strength. Over the past thirteen years, Ulta has had a minimum current ratio of 1.48 and a maximum of 3.76. Ulta’s current ratio for the quarter ended July is higher than the median current ratio for the past thirteen years of 2.66.

This graph here shows Ulta’s Current Ratio compared to its competitors within the Global Specialty Retail industry. Ulta’s is within the middle of the spectrum in terms of their Market Cap but has a higher Current Ratio than the other competitors shown on this graph. Ulta’s current ratio maintains higher than the industry average of 1.5.

Asset Management Ratios

Ulta Salon Cosmetics & Fragrance Inc.'s cost of goods sold for the three months ended in July 2016 was $684 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s average inventory for the quarter that ended in July 2016 was $887 Mil. Therefore, Ulta’s inventory turnover for the quarter that ended in July 2016 was 0.77. This lower ended ratio can indicate that possibly Ulta may have excess inventory because they do not have low sales. Ulta Salon Cosmetics & Fragrance Inc.'s account receivable for the three months ended in July 2016 was $56 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s revenue for the three months ended in July 2016 was $1,069 Mil. Hence, Ulta Salon Cosmetics & Fragrance Inc.'s days sales outstanding for the three months ended in Jul. 2016 was 4.78. This is the average amount of days that this company takes to collect revenue after the sale has been made. Ulta is below the industry’s median of 12.54 and they are also doing better than 73% of companies in this industry. The quicker Ulta can collect its outstanding receivables, the better.

Ulta Salon Cosmetics & Fragrance Inc.'s Revenue for the three months ended in July 2016 was $1,069 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s Average Total Assets for the quarter that ended in July 2016 was $2,262 Mil. Therefore, Ulta Salon Cosmetics & Fragrance Inc.'s asset turnover for the quarter that ended in July 2016 was 0.47. The Asset Turnover ratio was previously 1.86 at the period ending January 2016. The sales for the quarter ending July 2016 was much less than the sales for the period ending January 2016 and hence why there was

such a huge drop in the turnover ratio. This can be a warning sign since the assets have grown faster than the sales for this quarter but there is no doubt that with Ulta’s plans and focus on long-term growth that it will definitely boost the turnover within the next quarter.

Debt Management Ratios

Ulta Salon Cosmetics & Fragrance Inc.'s current portion of long-term debt for the quarter that ended in July 2016 was $0 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s long-term debt for the quarter that ended in July 2016 was $0 Mil. Ulta Salon Cosmetics & Fragrance Inc's total equity for the quarter that ended in July 2016 was $1,392 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s debt to equity for the quarter that ended in Jul. 2016 was 0.00.

Ulta Salon Cosmetics & Fragrance Inc.'s operating income for the three months ended in July 2016 was $144 Mil. Its operating income for the trailing twelve months (TTM) ended in July 2016 was $571 Mil. Ulta Salon Cosmetics & Fragrance Inc's interest expense for the three months ended in July 2016 was $0 Mil. Its interest expense for the trailing twelve months (TTM) ended in Jul. 2016 was $0 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s Operating Income for the three months ended in Jul. 2016 was $144 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s Interest Expense for the three months ended in Jul. 2016 was $0 Mil. Ulta Salon Cosmetics & Fragrance Inc. has no debt.

Profitability Ratios

Ulta Salon Cosmetics & Fragrance Inc.'s operating income for the three months ended in July 2016 was $144 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s revenue for the three months ended in July 2016 was $1,069 Mil. Therefore, Ulta Salon Cosmetics & Fragrance Inc.'s operating margin for the quarter that ended in July 2016 was 13.45%. Ulta’s operating margin is expanding. Margin expansion is a good sign. Ulta Salon Cosmetics & Fragrance Inc.'s 5-Year Average Growth Rate for operating margin was 7.90% per year. Ulta Salon Cosmetics & Fragrance Inc.'s gross profit for the three months ended in Jul. 2016 was $385 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s revenue for the three months ended in Jul. 2016 was $1,069 Mil. Therefore, Ulta Salon Cosmetics & Fragrance Inc.'s Gross Margin for the quarter that ended in Jul. 2016 was 35.99%. During the past 13 years, the highest Gross Margin of Ulta Salon Cosmetics & Fragrance Inc. was 35.30%. The lowest was 30.23%. And the median was 34.00%. Ulta has a competitive eroding margin with this ratio.

This graph represents where Ulta stands in terms of Gross Margin and Market Cap against the industry competitors.

Ulta Salon Cosmetics & Fragrance Inc.'s annualized net income for the quarter that ended in July 2016 was $360 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s average total assets for the quarter that ended in July 2016 was $2,262 Mil. Therefore, Ulta Salon Cosmetics & Fragrance Inc.'s annualized return on assets (ROA) for the quarter that ended in July 2016 was 15.91%. During the past 13 years, Ulta Salon Cosmetics & Fragrance Inc.'s highest Return on Assets (ROA) was 15.46%. The lowest was 4.87%. And the median was 12.58%.

This graph represents the growth in ROA for the past few years.

Ulta Salon Cosmetics & Fragrance Inc.'s annualized net income for the quarter that ended in July 2016 was $360 Mil. Ulta Salon Cosmetics & Fragrance Inc.'s average shareholder equity for the quarter that ended in July 2016 was $1,356 Mil. Therefore, Ulta Salon Cosmetics & Fragrance Inc.'s annualized return on equity (ROE) for the quarter that ended in July 2016 was

26.55%. During the past 13 years, Ulta Salon Cosmetics & Fragrance Inc's highest Return on Equity (ROE) was 25.16%. The lowest was 5.86%. And the median was 21.55%.

Market Value Ratios

As of today, Ulta Salon Cosmetics & Fragrance Inc.'s share price is $263.62. Ulta Salon Cosmetics & Fragrance Inc.'s diluted earnings per share for the trailing twelve months (TTM) ended in July 2016 was $5.67. Therefore, Ulta Salon Cosmetics & Fragrance Inc.'s P/E ratio for today is 46.49. During the past 13 years, Ulta Salon Cosmetics & Fragrance Inc.'s highest P/E Ratio was 129.68. The lowest was 10.23. And the median was 34.02. So basically, it takes Ulta 46.49 years to pay back the share price of $263.62, assuming the earnings stay constant over the next 46.49 years.

The growth rate we use is the 5-year average EBITDA growth rate. As of today, Ulta Salon Cosmetics & Fragrance Inc.'s P/E (NRI) Ratio is 46.49. Ulta Salon Cosmetics & Fragrance Inc.'s 5-year average EBITDA growth rate is 27.20%. Therefore, Ulta Salon Cosmetics & Fragrance Inc.'s PEG for today is 1.71. A company with a P/E ratio similar to its growth rate is fairly valued. Ulta may be overvalued in this instant since its P/E ratio is a little less than double its growth rate.

As you can see from this chart, Ulta’s PEG ratio hit a high of 5.57 in the year 2012 but has decreased down to 1.37 in Jan, 2016. Its P/E ratio was much higher in the year 2010 but is slowly decreasing to a fairly valued company.

As of today, Ulta Salon Cosmetics & Fragrance Inc.'s share price is $263.62. Ulta Salon Cosmetics & Fragrance Inc.'s Book Value per Share for the quarter that ended in July 2016 was $22.31. Hence, Ulta Salon Cosmetics & Fragrance Inc.'s P/B Ratio of today is 11.82.

Key Sector/Industry Information

The Retail - Specialty industry consists of companies engaged in the operation of stores and dealerships concentrated on a single product. The specialty industry includes car and truck dealerships, auto parts, home improvement, office supplies, books, kitchen wares, housewares, garden centers, toys, sporting equipment and other focused retail operations. The Retail - Specialty industry excludes stores specializing in computers and other technology products, classified in Retail - Computers & Electronics; and stores specializing in jewelry, luggage, men, women, and children's clothing, classified in Retail - Apparel & Accessories. The major competitors in the retail specialty industry are The Michaels Companies Inc., Grandvision B.V., Staples Inc., Signet Jewelers Limited, Dufry AG, Dick’s Sporting Goods, Inc., Tiffany & Co. and Ulta Salon Cosmetics & Fragrance Inc.

Right now, there seems to be an increased focus on personal service and product uses. This includes services such as eyebrow threading, massage, body shapers, nail art, body jewelry and cash for gold. All these services and products offer the consumer an opportunity for a small personal indulgence. Other trends across this industry are that consumers tend to look out more for good deals on products because they are more value-oriented. Retailers will react to this trend by wanting to open up more outlet locations across the country to benefit more consumers. Every cart, kiosk, and in store manager should be devising value-oriented promotions, sales and social media platform campaigns in order to broaden their reach out to consumers that are hesitant to pay the full price.

Everyone is talking about omni-channel retail these days. It’s all about creating a seamless customer experience that marries the brick-and-mortar store with online shopping channels, mobile devices, computers, direct mail, radio, TV and more. While omni-channel may have started with physical stores trying to figure out how to leverage online and mobile retailing, the first quarter of 2015 finds more and more online-only retailers recognizing the need to have a physical presence. This mindset change signals potential new franchise opportunities, or a new kiosk or pop-up shop.

Risk and RewardsMarket risk represents the risk of loss that may impact our financial position due to

adverse changes in financial market prices and rates. Ulta’s market risk exposure is primarily the result of fluctuations in interest rates. They do not hold or issue financial instruments for trading purposes. Ulta is exposed to interest rate risks primarily under their credit facility when they borrow. Interest on the borrowings is based upon variable rates. They did not access their credit facility during the 26-week period ended July 30, 2016. The interest expense recognized in the statement of income represents unused fees associated with the credit facility. Interest expense is offset by interest income from short-term investments with maturities of twelve months or less from the date of purchase.

Investment in the common stock involves a high degree of risk and uncertainty. The health of the economy in the channels Ulta serves, may affect consumer purchases of discretionary items such as beauty products and salon services, which could have a material adverse effect on our business, financial condition, profitability and cash flows. Also, they may be unable to compete effectively in our highly competitive markets. Any significant interruption in the operations of Ulta’s distribution facilities could disrupt their ability to deliver merchandise to the stores in a timely manner, which could have a material adverse effect on our business, financial condition, profitability and cash flows. Cybersecurity breaches and other disruptions could compromise their information, result in the unauthorized disclosure of confidential guest, employee, Company and/or business partners’ information, damage their reputation and expose them to liability, which could negatively impact Ulta’s overall business.

The stock fell about 37% back in late 2013 and early 2014 when the company missed its revenue and earnings expectations. More recently, the stock fell 19% during the stock market's drop at the beginning of the year. The stock has since recovered, but investors should be aware of the volatility.

On the other hand, rewards are a great possibility for Ulta. Ulta has a strong loyal and active customer base. Over 20 million Ulta Beauty guests are active members of the Ultamate Rewards loyalty program. Ulta uses this valuable proprietary database to drive traffic, better understand their guests’ purchase patterns and support new store site selection. They regularly employ a broad range of media, including digital, catalogs and newspaper inserts and targeted promotions driven by our CRM platform, to drive traffic to the stores and website.

Ulta also has strong vendor partnerships across product categories. They have strong, active relationships with over 350 vendor partners, including Bare Minerals, Coty, Estée Lauder Companies, L’Oréal and Procter & Gamble. Ulta also has an experienced senior management team. Ulta also will grow their rewards by using the six strategic imperatives, to acquire new guests and deepen loyalty with existing guests, differentiate by delivering a distinctive and personalized guest experience across all channels, offer relevant, innovative and often exclusive products hat excite their guests, deliver exceptional services in three core areas: hair, skin health and brows and grow stores and e-commerce to reach and serve more guests.

Summary

After reviewing Ulta’s growth plans, financials and investment case, it can be said that they are a very good company currently and have a lot for plans for future growth. Not only is Ulta the largest beauty retailer within the United States, but they are also expanding their current store locations from 900 to between 1200-1400 by the year 2019. This is going increase revenues and consumer spending on the products Ulta has at each store location. Along with being Proactiv’s first national retail partner, the customer base will only grow more and more. The Ultamate Rewards Program also helps a lot with Ulta’s growth as a company due to the growing base of members ranging over twenty million currently. Another growth opportunity which make Ulta a great buy, is the partnership formed with Alliance Data Systems Corp. to provide private label and co-branded credit card services. The branded credit cards will help develop the relationship with the customer and also improve the experience of the Ultamate Rewards Program.

Ulta’s CEO Mary Dillon plans to double its current market share of 4% of the beauty market within the next few years. The beauty market is worth $127 billion. Ulta’s plans for targeting three main segments will also expand their customer diversity and overall base. Along with improving their e-commerce and mobile platform, Ulta will be able to reach their targets. The projected income for the Millennial group is approximately $8.3 trillion by 2025 due to the fact this group shops 32% more than the average customer.

While Ulta is still subject to risks, they also have many rewards. The risks are to be taken into consideration though and should not be overlooked. For example, distribution problems which could further prevent delivery time can be a huge problem especially when wanting to infiltrate these new target segments. Another risk which can also be huge of a problem would be cybersecurity breaches and hacks which can damage Ulta’s reputation and expose them to liabilities. While all companies will have risks, they will still have rewards.

Ulta’s experienced senior management team will help the company reap more benefits and rewards by following their six strategic imperatives mentioned above. Their strong relationships with over 350 vendors will only help improve Ulta’s reputation and help improve their future

growth. Year over year, Ulta has growth in their financials such as Net Sales, Comparable Sales Increase and Earnings Per Share.

With constant growth year over year in terms of financials and also the future growth plans set out by the CEO Mary Dillon, one can only imagine the amount of growth that Ulta has for the future as they keep their title of being the largest beauty retailer within the United States.Ulta stands as a great buy in a growth portfolio.

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