2023-12-08 09:59:03 ET
Summary
- Ulta Beauty is expected to achieve revenue of $11 billion to $12 billion this year due to sustained consumer demand and expertise in introducing new products.
- The company reported robust Q3 earnings, beating estimates and experiencing strong customer demand, despite some challenges in sales growth.
- Ulta has the potential for M&A-driven expansion in the services sector, which could attract new customers and increase in-store traffic.
Thesis
Ulta Beauty, Inc.'s ( ULTA ) strong position in the beauty industry positions the company to achieve revenue in the range of $11 billion to $12 billion this year, driven by sustained consumer demand. The company’s expertise in introducing new products, a notable strength, coupled with regular product restocking, should enable it to maintain revenue growth even in the face of economic challenges. Despite the macro challenges, I believe there is a lasting demand and opportunities for both long-term sales growth and margin improvement. I remain positive on the prospects of the company and assign a buy rating to the stock.
Post-3Q Earnings Review
Ulta Beauty posted robust results for Q3 2023 reporting revenue of $2.49 billion, beating estimates by $20 million. The company also beat estimates on the bottom line posting Q3 GAAP EPS of $5.07, beating estimates by $0.10. Ulta Beauty is expected to experience a sales growth of 7-8% in the fourth quarter, thanks to improved full-year sales forecasts, indicating strong customer demand. Despite fewer new stores opening and some customers shifting from high-end brands to more affordable ones, which has caused a slowdown in sales growth in the second half of the year, the company's performance is still solid.
The management's unchanged estimate of a 14.6-14.8% operating margin for the year suggests that the fourth quarter's margin might be similar to the third quarter's 13.1%, which is different from the trend of declining margins seen over the past two years. Additionally, the fact that promotions are still below pre-pandemic levels is a positive sign for the company's long-term profitability.
Potential for M&A-Driven Expansion in the Services Sector
Ulta Beauty has a strong financial position with a debt to asset ratio of 0.6x and cash balance of $121 million. The company’s strong balance sheet provides it the flexibility to lever up in order to pursue strategic mergers and acquisitions opportunities. The company’s peers like Sephora have not focused on M&A in the recent past and driving growth through M&A could set Ulta apart from competitors as organic growth remains slower, especially if the acquisitions expand its service offerings.
Ulta enhancing its services could attract new customers, increase in-store traffic, and boost average spending per shopper. While Ulta is focused on organic store growth and reinvestment in the near term, I think M&A could present a longer-term opportunity to bolster market share. Companies such as Amazing Lash Studio and The Lash Lounge have rapidly expanded , and I see M&A potential in semi-permanent lash extensions and services for Ulta, adding to the retailer's existing product and service offerings. Currently, services make up only 3% of Ulta's sales. Additionally, the salon-services industry, valued at $50 billion, is fragmented, and Ulta holds just a 1% market share, leaving ample room for consolidation.
Skin and Hair Products Positive for Growth
Skin and hair care products, which make up a combined 39% of Ulta's sales in the first half of the year, are important growth categories for the company in the current year. These categories also have the potential to contribute positively to the company's profit margins. The growth rate in skin and hair care products outpaced that of cosmetics, and this trend may continue as new products are introduced to the market, and consumers place greater emphasis on these categories in their beauty routines. I believe that there is a possibility for Ulta to achieve better-than-expected same-store sales growth. Additionally, the expansion of store fleet and ongoing partnership with Target (TGT), could support sales growth.
Company Presentation
Valuation
Ulta's strong presence in both digital and physical retail spaces is a significant factor in driving product discovery, customer acquisition, and engagement. In the digital realm, Ulta Beauty offers an interactive and user-friendly online shopping experience, complete with detailed product information, customer reviews, and virtual try-on features. The company has been focused on integrating Gen AI to virtual try-on options which will improve the overall online purchasing experience for shoppers. These aspects offer promising long-term opportunities for increasing sales. Ulta's various customer touchpoints, whether online or in-store, are expected to lead to continued growth in the number of rewards members and their annual spending. Currently, Ulta boasts over 40 million such members, who contribute to approximately 95% of the company's sales. With both membership numbers and spending per member on the rise, I anticipate that the company's top-line growth will continue into fiscal 2024. Despite the sustained demand, Ulta's adjusted operating margin are facing challenges due to increased costs and theft prevention measures.
Ulta is currently trading at a forward PE of 18x as per Capital IQ estimates. The current multiple is slightly higher than sector median of 15x. The company’s multiple has trended down from 31x in 2021 as the growth has normalized under a tough macro environment. However, I think the current multiple is depressed and has accounted for slowing earnings growth in the future. Moreover, the company has been beating market estimates both in terms of topline and EPS and I believe the stock has a good upside potential and the current valuation discount provides a good opportunity to buy the stock at reasonable levels. Hence, I assign a buy rating to the stock.
Capital IQ
Risks to Rating
ULTA is a stock with a growth potential and is trading at a relatively higher valuation than the sector median. It's important to note that if same-store sales decline, it could lead to market expectations not being met, potentially causing a revaluation of the stock. Additionally, the cosmetics industry, particularly color cosmetics, has seen declining growth recently, which could further impact ULTA's comparable store sales. Given the tough consumer environment, ULTA's quarterly results may experience fluctuations leading to a decline in the stock price.
Conclusion
The trend toward a resurgence in the demand for services persists, albeit with some signs of slowing down, and Ulta plays a significant role in this evolving landscape. Leveraging its unparalleled understanding of its customers through access to valuable data, the services segment presents an area where the company can grow in the future and grow its market share as it currently has very low penetration in the segment. The stock trades at a reasonable valuation and I assign a buy rating to the stock.
For further details see:
Ulta Beauty: Remains Well-Positioned Despite Macro Weakness