Editor’s note: This column is part of our Best Stocks for 2017 contest. Tracey Ryniec’s pick for the contest is Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA).
If you had to choose one stock to buy for 2017, your first thoughts probably wouldn’t go to the retail names.
2016 was, in general, a terrible year for America’s retailers. While employment continued to improve and wages finally started to rise, the consumer was in a funk. While they might have bought those tools from Home Depot Inc (NYSE:HD), they completely shunned clothes of any kind and turned their backs on the big department stores.
In the weeks leading up to the presidential election, most retailers reported an even further slowdown in spending. It’s almost as if the consumer was paralyzed.
But the post-election world is a very different place. Retailers who reported earnings after the November election almost unequivocally said they saw a big jump in business in the weeks afterwards.
Consumers were spending again.
Will these new animal spirits last until 2017? No one knows. But many economic fundamentals seem to support the idea that this pick-up in consumer spending, and sentiment, could have legs.
The employment market continues to heat up. There’s also the possibility of infrastructure spending and tax cuts in the new year, which could boost economic growth further.
Additionally, the importance of the stock market indexes trading at new all-time highs shouldn’t be dismissed. When investors look at their investment statements and they see those balances rising, it can also boost the animal spirits. They feel richer. And when they feel richer, they spend more.
The First Rule of Investing: Buy the Best
If consumers are opening their wallets again, then investors should be in the very best of the retail group.
And there can be only one name that falls into that category.
Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA).
Ulta sells beauty products and operates salons in 949 stores in 48 states and the District of Columbia.
Right now, ULTA stock is the only retailer that is producing double-digit comparable-store-sales quarter after quarter and year over year. Additionally, unlike most other retailers in 2016, Ulta didn’t see its business slow during the year. Quite the opposite occurred. It has actually accelerated.
Here are the quarterly comparable-store-sales for 2015 and 2016.
| Fiscal 2015 Comparable Stores Sales Growth | Fiscal 2016 Comparable Store Sales Growth |
| Q1: 11.4% | Q1: 15.2% |
| Q2: 10.1% | Q2: 14.4% |
| Q3: 12.8% | Q3: 16.7% |
| Q4: 12.5% | Q4: ??? |
What other retailer is doing comparable store growth of 16.7% like Ulta did in the third quarter of this year?
No one.
It’s not even close. Ulta stands alone.
Why Ulta Crushes It
How is ULTA stock able to achieve this kind of success when other retailers have been faltering?
Let’s be frank. It helps that it’s not an apparel retailer. Makeup, in particular, has been an especially strong retail product line for the last several years and shows no signs of slowing down.
But outside of its products, it’s also doing several things right that allow it to trounce the competition.
1. Best Rewards Program In the Business
First, it has the best rewards program, the Ultamate Rewards, in the retail industry. The rewards program now accounts for 90% of all sales.
The reason it is so great is that it legitimately gives customers rewards. It makes it easy to accumulate points, which can then be applied to other products. So a customer in the program, knowing that they will get good freebies, will try and make as many purchases as they can through the rewards.
Not only will they buy their makeup at Ulta, but also buy their shampoo and even get their haircut there just to accumulate points.
The rewards program also provides a moat against Amazon.com, Inc. (NASDAQ:AMZN) and other online retailers. Why would women buy their makeup on Ulta.com instead of Amazon, which often carries the same items, sometimes for less? Because they don’t get points on Amazon.
Points, and the rewards that come with them, are the name of the game. It has created an incredibly loyal customer base.
2. Unique Shopping Experience
Like every retailer in the last 10 years, Ulta has been growing its online retail presence. It has opened up distribution centers in key locations across the United States to assist with order fulfillment and delivery. A few years ago it also redesigned its website to make it more user-friendly.
That has translated into big growth in its online sales. In the fiscal third quarter of 2016, ecommerce sales rose 59.1% to $73.6 million from $46.2 million in the year ago quarter.
But even with that strong growth, online sales were just 240 basis points of its 16.7% comparable-store-sales growth.
That means most of the sales are still coming from the brick-and-mortar store.
Those are growing because Ulta has incorporated hair salons, skincare and brow services into every one of its stores. This brings foot traffic into the stores. In the third quarter of 2016, for example, comparable salon sales rose 10.3%.
Ulta also has an extensive sales presence on the shopping floor to help with any questions about products. Customer service matters.
Additionally, it has exclusive deals with many beauty product lines which have also boosted store traffic.
3. Strong Earnings Growth Until 2019
In October 2016, Ulta held an Investor Day conference where it outlined its plans for the next three years.
By 2019, it expects to have store count in the U.S. in the range of 1,400 to 1,700, up from the current level of 949. There was no talk of expanding, yet, outside of the U.S.
For fiscal 2016, with sales exploding higher, it expects earnings to grow in the high 20% range. That continues its string of strong year-over-year earnings growth.
But it is equally optimistic for 2017, 2018 and 2019. It sees earnings growth still averaging in the low 20% area for that entire time, despite coming off a much bigger base which makes it more difficult to grow at such a strong pace.
ULTA Stock Priced for Perfection?
By my very nature, I’m a value investor. So it’s ironic that I have picked a stock for 2017 that is in no way, shape or form a “value” stock.
There’s no way to sugar coat it. Ulta is expensive.
It trades with a forward price-to-earnings ratio of 32.8. It also doesn’t pay a dividend, although it has been doing a share buyback program recently.
This is a pure growth play.
But ULTA stock has one of the best management teams in the retail industry and it has been consistently living up to expectations. The one danger is that expectations have gotten so high — such as that 16.7% comparable-store-sales comp in the third quarter of 2016 — that there is no way the company can exceed them.
Many on Wall Street believe it’s only a matter of time before Ulta slips up on a quarter and the shares drop.
You can see some of the jitters in the one-year chart, as shares have been moving sideways since the fall of 2016.
But Ulta’s fundamentals justify its expensive price. The growth is there. All the company needs to do is execute.
And with the economy starting to heat up, and the consumer willing to spend more, ULTA stock should be a prime beneficiary. I still see more upside for the shares next year.
If you’re going to be in retail in 2017, be in the best.
Tracey Ryniec is an Equity Strategist and Portfolio Manager at Zacks Investment Research. She manages the Insider Trader and Value Investor services. As of this writing, she owned shares of ULTA in her personal portfolio.
