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Is Ulta’s Operating Margin Under Pressure?

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Margins in fiscal 4Q16

Ulta Beauty’s (ULTA) gross margin declined in fiscal 4Q16 (ended January 28, 2017). However, the company’s operating margin improved on a YoY (year-over-year) basis. Ulta Beauty’s gross margin fell 10 basis points to 34.5% in fiscal 4Q16 because the leverage in fixed store costs (due to strong sales) was offset by supply chain investments and a higher mix of online sales.

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Improved operating margin

Ulta Beauty’s operating margin rose to 14.2% in fiscal 2016, as compared to 13.4% in fiscal 4Q15. This improvement stemmed from the company’s ability to leverage its advertising expenses and corporate overhead on strong sales volumes in 4Q16. Factors that negatively impacted the company’s 4Q16 operating margin included investments in store labor in connection with prestige brand expansions and higher staffing levels, mainly during the holiday season.

For fiscal 2016, Ulta Beauty’s gross margin rose 70 basis points to 36.0%. The company’s operating margin also improved to 13.5% in fiscal 2016, which was just up from its 12.9% in fiscal 2015.

Measures to improve margins

In the company’s 4Q16 conference call, Ulta Beauty’s CFO (chief financial officer) Scott Settersten stated that the company expects a modest increase of 20–30 basis points in its fiscal 2017 operating margin. The company’s goal is to generate an operating margin of 15.0% by the end of 2019.

Higher online sales have helped Ulta Beauty’s top line but have put pressure on the margins, given the investment involved in online infrastructure. Retailers and department stores are aggressively investing in their online channels to compete with Amazon.com (AMZN), but this approach is hurting profitability. Macy’s (M), which is expanding its presence in the beauty business through Bluemercury, reported a 240-basis-point decline in its operating margin to 5.1% in fiscal 2016. Macy’s operating margin was impacted by higher impairments, store closing, and other costs.

Meanwhile, Ulta Beauty expects its loyalty program, supply chain efficiencies, procurement savings, and new store productivity gains to impact its margins positively going forward.

In the next part, we’ll explore Ulta Beauty’s growth strategy.

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