Ulta Beauty (ULTA -3.07%) has been one of the best-performing consumer discretionary stocks on the market over its history.
The company established itself as a clear leader in a unique niche of retail, selling more than 25,000 products from more than 600 brands, and it operates in-store hair salons, differentiating it from rivals like Sephora.
Since its initial public offering (IPO) in 2007, Ulta is up more than 1,000%, but over the last year, the stock has hit a roadblock. Year to date, the stock is down 24%, and the stock looks cheap enough to attract the attention of Warren Buffett, whose Berkshire Hathaway scooped up some Ulta shares in the second quarter, though the stock is even cheaper now than it was when Berkshire bought it.
Ulta was recently down 34% from its peak early this year, and for good reason, as sales have slowed from the company's formerly strong growth rate. Let's explore Ulta's recent challenges before discussing why it presents such an appealing buying opportunity.
Image source: Getty Images.
Ulta hits a wall
The sell-off in Ulta stock isn't unjustified. In the second quarter (ended Aug. 3), comparable sales fell 1.2%, a significant deceleration from the 8% gain it posted in the quarter a year ago, and revenue rose just 1% to $2.55 billion, missing the consensus at $2.61 billion. That weak performance continued a trend from the first quarter.
Profitability also took a hit with gross margin falling to 38.3% from 39.3% due to increased markdowns, and selling, general, and administrative expenses increased from 23.7% to 25.3% of revenue, which resulted from the deleverage from the decline in comparable sales.
As a result, operating margin fell from 15.5% to 12.9%, and earnings per share declined from $6.02 to $5.30, below estimates at $5.47.
Ulta also cut guidance for the full year. It now sees comparable sales between a decline of 2% and flat and slashed revenue from $11.5 billion-$11.6 billion to $11 billion-$11.2 billion. It also cut its earnings per share from $25.20-$26 to $22.60-$23.50.
Management said a decline in comparable store transaction weighed on the business, due to slowing growth in the beauty industry and increased competition, which is impacting Ulta's share in prestige beauty. The impact is particularly strong when new stores open nearby.
Ulta also seems to be losing market share to Sephora, which reported double-digit growth in revenue and profit globally. Sephora also cited the impact of its new partnership with Kohl's.
Why Ulta can bounce back
Most of Ulta's challenges seem to be temporary. The impact of nearby new store openings tends to be strongest when they first open, attracting consumers to try something new, but Ulta's loyalty program remains strong. Rewards members were up 5% from a year ago to 43.9 million, which should contribute to its long-term growth.
Management also said that new stores are performing well, and it continues to aggressively open stores with 60 to 65 new stores expected this year on top of its base of about 1,400 locations. Clearly, the company thinks there's still space to expand and penetrate the market.
It's a mistake to see two quarters of weak results as evidence of a broken company, and Ulta's discount offers a good buying opportunity as it now trades at a forward price-to-earnings ratio of 16.
For a company with Ulta's history of growth and success as well as its market opportunity, that looks like a great price to pay.
If you can look past the current challenges, Ulta should be in a better place in a year or two down the road as most of the issues facing it seem to be temporary. In addition to its store openings and the receding wave of competition, the business should benefit from falling interest rates, which will encourage consumer spending. Altogether, Ulta looks like a good bet for recovery.
