ULTA Earnings Review: Undervalued Enough!
ULTA Earnings Review: Undervalued Enough!
ULTA earnings were not great but this was highly expected. However, I think the business fundamentals still strong and doesn't deserve such undervaluation. It's still a strong buy for me!
Ulta missed earnings and the stock gave back much of the boost it gained after Warren Buffett disclosed a position. I think that was pretty exaggerated:
It posted $2.55 billion revenue vs. $2.61 billion expected.
Earnings per share was $5.30 vs. $5.46 expected.
Let me be straightforward with this:
Ulta earnings weren’t great.
It’s still a great business at a cheap price.
There is nothing that changed my thesis.
Yes, it missed earnings, but we can also look at it from this perspective: It missed both on top and bottom lines for the first time in 4 years!
If you knew nothing about the business and I told you this fact, you would think it should be a great business, and it is.
So, let me cut the BS and explain why I believe Ulta’s earnings weren’t indicative of its full potential:
📊Business Performance
This company missed earnings on both lines for the first time in the last 4 years.
When I say this may, it may not strike as impressive as it really is so let just say what macroeconomic conditions we have been through in the last 4 years:
Covid-19 recession.
0 interest rate policy.
Historically high inflation.
Record fast interest rate hikes.
This business adapted to all these conditions and it thrived.
In the last 5 years, it grew earnings 17% annually.
It’s an amazing business performance. I don’t know any investor who wouldn’t be amazed by such an earnings growth, especially by the company that was already the leader in its industry.
This gets even more impressive when you take into account that its median Return on Equity (ROE) in the last 10 years was staggering 35%.
So, you are looking at a business that made, on average, 35% annually on the shareholders’ money in the last 10 years and grew its earnings 17% annually in the last 5 years. If you ask me, this is a mind blowing performance.
This is the first time it missed earnings in the last 4 years, and we find it trading at 13 times earnings. This is not fair and should be exploited by intelligent investors.
When we understand the reasons for the low-performance, I believe it will be easier for us to see through.
First let’s remember that we are currently in a very hard macroeconomic conditions for the consumer businesses:
Inflation is still above target.
Interest rates are at their highest since 2008.
Consumers started to feel restrictive effects.
The job market growth is lower than expected.
All these reasons naturally result in a consumer pull-back. This is also illustrated by the bad performances of consumer companies like Nike, Starbucks and McDonald’s. Even Amazon missed on revenue despite reaccelerating AWS growth.
Given this situation, I think Ulta is doing extremely well partly because the fact that cosmetics is probably the most defensive discretionary spending item. The reason is simple: Women don’t cut back on cosmetics unless they really have to. Results show this:
Q2 Net sales still increased 0.9% YoY.
First half net sales still increased 2.2% compared to the first half of 2023.
The consumer is still buying, but the growth rate has indeed declined. They are perhaps more selective now, but still, the market looks strong.
So, the overall slow-down in consumer spending was one reason, what are the others?
I listened to the whole conference call and the CEO Dave Kimbell advanced one other major reason than the overall cooling in demand: Competition.
Competitors like Sephora and Elf opening new stores around Ulta locations exerted a significant competitive pressure on the business. This resulted in 1.2% decrease in same-store sales.
Indeed, the company posted its lowest quarterly gross margin since 2020.
However, competition’s tiny effect on the gross margin doesn’t actually bother me. In no way we are looking at cannibalization of the gross margin by competition. This is more like a stress test and where the business is doing so good so far. It feels like competition, but it is not losing to it.
There is also one other reason why I am not very concerned about competition: I think the industry is quite resistant to disruption.
Generally, the biggest threat I see for such businesses is e-commerce. However, cosmetics is distinctly positioned in this. Women love the experience of trying cosmetics and talking to consultants in the store. Buying cosmetics has a huge experience dimension. They can’t get the same experience in e-commerce. They can get the experience in store and then order online but the price isn’t gonna differ much to justify sacrificing a part of the experience, which is leaving the store with something you tried and fell in love with.
This leaves us the classical competition as the main concern.
I am relieved because the playbook is well-known when it comes to traditional competition: Price, differentiation and consumer experience. The largest business in the town is exceptionally well positioned to deliver on all these metrics.
Its main competitors are now Sephora and Elf. They indeed exert some competitive pressure but will they replace Ulta? I don’t think so. Ulta is on pace to gain net 60 stores this year despite the industry slow-down. Even if we act conservatively and assume that this will never increase, Ulta will have 50% more stores in 2034.
Note that Ulta can do much more than this as it’s planning to launch in Mexico in 2025.
So, what about the earnings, which missed expectations by a higher margin?
Well, the business made $250 million this quarter compared to the $300 million same quarter last year.
This is due to two reasons: Flat revenue and higher general expenses.
It spent $100 million more in Selling, Administrational and General Expenses this quarter. However, the CEO explained in the conference call that most of this money was spent in strategic investments. So, given that the business has exceptionally high ROE, increasing investment doesn’t bother me at all.
Yes we have a bit less earnings this quarter, but we will see the return!
Overall, I don’t think the Ulta quarter was as bad as people expected it would be.
📝Investment Thesis
If you don’t know my detailed Ulta investment thesis take a look at my first deep dive on the company:
In short, my Ulta investment thesis relies on three pillars: cosmetics is less cyclical than other discretionary spending, Ulta’s earnings are consistent, and Ulta is buying back huge amounts of stock.
Let’s revisit all these points and discuss whether the recent earnings have changed any of these points.
Beauty is less cyclical.
I think this is obvious.
As you see the US beauty market shrunk only 6.4% in 2020 despite the fact that we were living under lockdowns. This shows us that people buy cosmetics even if they have limited opportunity to use them. It’s not something that you buy just to use, it’s like a hobby. There is joy in buying cosmetics even if you don’t need it. It’s embedded in human nature, especially in women.
We see that despite the huge pullbacks in other discretionary spending, like athleisure, beauty spending remains relatively strong. We don’t observe a pull back like we saw in the ones like Nike and Starbucks.
Ulta has consistent earnings.
It missed expectations but do we see erratic moves in earnings? No. It missed but it didn’t collapse.
Honestly, even if it collapsed, it wouldn’t mean much. If you believe the first earnings miss of a company in 4 years shows more than 4 years of consistent earnings, you don’t have to be in investing.
Even if we take the lower end of the guidance, %3 decline in revenue, this could easily be attributed to macroeconomic conditions.
I don’t see any chance in the business fundamentals.
Ulta is a cannibal stock.
In the last 5 years, the company averaged 3.5% annual buyback rate.
In Q1 2024, the company bought back 588,000 shares for a total of $285.1 million. In this quarter, it repurchased 549,852 shares of its common stock at a cost of $212.3 million. In total the company bought back 1.1 million shares of its common stock at a cost of $497.5 million.
It still has $1.6 billion remaining available under the $2.0 billion share repurchase program announced in March 2024. This allows the company to buy back 10% of the company at the current valuation.
Given that Ulta generally authorizes buybacks for two year periods, we can see that it’s dedicated to maintaining this buyback rate in the future.
Overall, despite the miss, nothing happened to change my Ulta investment thesis.
📈Valuation
Given that nothing much has changed in the fundamentals, not much has changed in. my valuation too.
Of course growth estimates have come down, even my own estimate, however, the price has come down too so I believe the stock is still as attractive as when I first published my deep down.
Given the consistent earnings of the company, we can assume that Ulta will grow revenue around 6% annually in the next 5 years. This will give us $15.1 billion revenue for FY 2029.
Ulta’s median profit margin in the last 5 years was little over 11%. Normally, you would expect this profit margin to expand due to increasing operational efficiency and AI applications. However, I will remain conservative and only assume 11% adjusted profit margin for 2029. This gives us $1.6 billion net profit.
Now, given that Ulta is dedicated to buyback around 3.5% of outstanding shares annually, we will have 41 million shares outstanding in 2029.
This gives us $39 earnings per share.
Given that buybacks, combined with consistent earnings growth, create significant multiple expansion, we can easily attach 20 times earnings which gives us a $780 price target for FY 2029.
This is 17% annual returns.
I don’t know about you but given the low risk profile of Ulta, 17% annual return is highly attractive for me.
🏁Conclusion
Ulta is still attractive.
Yes, it missed earnings but nothing fundamental changed and there is nothing that can endanger the future of the business.
The industry proved resilient and Ulta is still doing good compared to other consumer companies. The growth estimates came down due to the stagnant performance this year but so did the price.
The important thing is how you are going to use Ulta in your portfolio, it’s about the broader portfolio strategy. If you expect Ulta to deliver bulk of your returns and take your portfolio to the new highs, you may get disappointed and end up selling at a loss. The right way to look at is seeing a good and undervalued business that is maturing. You should put at most around 10% of your money in Ulta, thinking that heads you win, tails you don’t lose.
This is how I am playing it.
What's more important - quarterly reports or yearly in terms of missing earnings/EPS?
Great write up…important to properly categorize the company and what its performance attributes will be in the future. It will beat the index over next 5 years but top line growth will not be the driving characteristic.