ULTA: Will Earnings Be Looking Good?

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Almost every woman I know has a medicine cabinet full of beauty products amassed over the years. Even women who wouldn't call themselves high maintenance own a plethora of cosmetics, hair products, groomers, straighteners, dryers, fragrance and on and on. And where do they go to replenish their beauty stores? They've been going to Ulta Salon (NASDAQ: ULTA) if the company's numbers have been any indication.

Ulta has been quite the outperformer and it's reporting Q3 results on November 29. Will the nation's largest beauty product retailer (over 20,000 products) also offering salon services for both men and women maintain its superior performance as it did last quarter beating on both top and bottom lines? Usually one can gauge earnings by the performance of competitors on the same quarter. But on their latest earnings reports rival Regis Corp (NYSE: RGS) disappointed badly and Sally Beauty Supply (NYSE: SBH) announced profits rose and beat analyst expectations.

Ulta pulled back big from its high of $103.52 when the CFO left in October, but both RW Baird and Goldman Sachs saw the weakness as a buying opportunity with Goldman giving a price target of $115. This turnover in the CFO position has pressured the stock. Former CFO Gregg Bodnar presented the numbers at the last ER on September 6 with Bruce Hartman to become CFO the next day. Then Hartman resigned in mid-October. Ulta appointed Scott Settersten as interim CFO and announced the company would continue to search for a new CFO.

Gaga Over Grooming 

CEO Chuck Rubin was particularly upbeat on the company's Q2 call in which he laid out their five prong growth strategy:broadening market reach with in-store events and media, enhancing their customer loyalty reward program, introducing new products and services, expanding and renovating current stores, and finally  improving the Ulta.com site and expanding their digital and social media presence.

In pursuit of these goals the company has been spending quite a bit on advertising and promotion. Notable promotions included Frizz-Free Fridays to introduce customers to a new salon service, special straightening blowouts. There was also spending in connection with the introduction of a Lady Gaga fragrance which turned out to be a big hit as well as the rollout of premium cosmetic brands Lancome and Clinique. Rubin noted the Clinique and Lancome additions will not add to this years' numbers.

As for the customer loyalty reward program membership reached a 10 million member milestone (active shoppers for at least one year) and they've been improving customer reach with members only promotions.

The largest beauty product supplier in the US also announced on the call they have been increasing store count and remodeling existing stores. New stores are opening faster than planned and once open are performing better than stores opened the year before. They increased numbers for possible store count from 1,000 to 1,200 stores in the US. Store count currently stands at 489 stores in 45 states. This year alone they are opening 100 new stores and remodeling 21 stores. With these initiatives capital expenditures have risen to $180 million in 2012 from $129 million the year before, mostly due the opening of the new stores and a new distribution center in the Northeast.

Is Ulta Too High Maintenance?

Ulta's P/E is 40.45 with a forward P/E of 27.43. However, the company has some attractive aspects: the company has no debt, the insider hold is 22.49%, and the return on equity is 25.58%. In Q2 margins were up considerably with gross profit margins up 80 basis points to 34.8% and operating margins up 180 basis points.

On the call CFO Bodnar guided for a negative impact on operating margin in the third quarter because of the opening of 52 new stores. He predicted EPS in the range of $0.54-56 and sales in the $494 to $503 million range, a 20% improvement over the last Q3 and for same store sales to rise 6-8%. But gross margins are only expected to expand by 60 basis points.

The question is will this be enough for analysts who have raised the bar even higher after two consecutive beats. Ulta is in a position of strength between its two rivals as it doesn't have the weakness of the beauty salons at Regis and it has a more general appeal and variety of its beauty products than Sally Beauty Supply which is targeted more to beauty professionals. At this point in their expansion one could say it most closely competes with Sephora owned by LVMH Louis Vuitton Moet Hennessey (OTC:LVMHUY) and Macy's (NYSE: M) with its collection of prestige brands like Clinique and Lancome and trained salespeople. But Ulta has salon services and aestheticians on staff.

The Price of Beauty

Ulta may be sitting pretty between competitor Regis with its return on equity of -10.62% and Sally Beauty Supply with a of P/E of 19.56 but total debt of 1.62 billion to cash of 240.22 million. However, the short interest in Ulta has grown by 25% from the end of September to November and already the company said EPS would be little higher than Q2's $0.54. Same store sales growth has been slowing slightly year over year and the aggressive expansion plans will compromise margin expansion.

Analysts will be questioning the status of the CFO position as well as closely scrutinizing the same store numbers and how much margins were really impacted by these expansions and remodeling. The stock has already risen twice as much as the S&P over 52 weeks despite the pullback in October. While analysts are still bullish with a mean price target of $112.14 this is a momentum retail name and could have a serious slide if analysts are not pleased. This is a name to be very closely watched and any positions taken before earnings should be small.

leglamp has no positions in the stocks mentioned above. The Motley Fool owns shares of Regis. Motley Fool newsletter services recommend Regis and Ulta Salon, Cosmetics & Fragrance. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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