This Long-Term Pick will Beautify your Portfolio

By Harsh Chauhan - June 11, 2012 | Tickers: M, ULTA, WFM | 0 Comments

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In times when austerity and budget cutbacks should be on top of your personal finance agenda, you wouldn’t expect a beauty retailer to post electrifying numbers. Well, if you are indeed thinking that way, Ulta Beauty (NASDAQ: ULTA) proved you wrong last week. Not only did Ulta meet Mr. Market’s expectations (beating on the bottom line), it also provided an upbeat forecast and saw its shares spike.

A strong legacy…

Going by the company’s past record, the earnings beat in the just-concluded quarter doesn’t come as a major surprise. Ulta is the biggest beauty retailer in the U.S. and has consistently edged ahead of analyst estimates for more than a couple of years. It has a wide portfolio of products in its arsenal and has been growing at a breathtaking speed.

The company has grown its top line at 19% annually over the past five years, which is certainly impressive considering that we had a recession in between. The jump in revenue has percolated down to the bottom line as well, with Ulta Beauty’s earnings growing 30% every year on an average over the same time frame. And as far as the stock’s performance is concerned, there’s just one word for it -- sweet. The stock is up almost 45% so far this year and has outperformed peers such as Macy’s (NYSE: M) and Nordstrom.

…with a bright future

Ulta Beauty’s same store sales surged 10% in the first quarter, a trend seen in Q1 for the last two years. And the company is making some serious efforts to see more days like this. It added 18 new stores in the previous quarter and won’t step off the gas anytime soon. Ulta Beauty plans to add another 82 stores this year, apart from the 18 it already opened. This will lead to a massive 22% jump in its square foot area, paving the way for further growth in top and bottom lines.

In addition, the company says that there is still a lot of bandwidth available for it to play in the market. Ulta Beauty’s analysis suggests that it can open 1,200 of its 10,000-square foot stores in the country, and it just had 467 at the end of the first quarter. This effectively means that Ulta Beauty has a lot of market left to be addressed since it currently caters to less than 40% of its possible customers. Moreover, Ulta Beauty is also expanding the range of products and services it offers such as increasing Lancome boutiques to another 50 stores.

Also, the company still hasn’t ventured into international markets. Management has kept that area of expansion on the backburner as of now as it aspires to further strengthen its foothold in the domestic market and tap its full potential. However, I believe that Ulta Beauty needs to shift its focus on the international markets in the near term rather than the long term that management is thinking of. Peer Macy’s has already made its entry into the Chinese e-commerce space and has also acquired a minority stake in a store in the country.

Delivering value

Going through Ulta Beauty’s earnings transcript was a pleasure. CEO Chuck Rubin provided a detailed outline of how his company’s real estate team works and that they won’t be opening stores “for the sake of hitting a number.” Ulta Beauty puts in a lot of study and layers of analysis before it invests in a new store, making sure that they deliver maximum returns to shareholders. And in its quest to return value, the company is doing is bit to reduce costs.

The company’s gross margin improved 110 basis points from last year along with a drop in selling, general and administrative expenses, which also declined by 110 basis points. The opening of a distribution center in Chambersburg has helped the company cut down on transportation costs along with strengthening its supply chain. Moreover, Ulta Beauty is focusing on selling more of its high-margin products, a move that will help it to improve its gross margin by another 80 basis points in the current quarter.

Expensive, but still good

Last month, fellow blogger Stephen Benz wrote an impressive piece in which he told investors to look beyond the price to earnings (P/E) multiple. In his example, he showed how Whole Foods (NASDAQ: WFM) was a better supermarket retailer than its peers such as Kroger and Safeway. Whole Foods, despite trading at more than two times the price multiple of its peers, is a faster growing company with better margins, and hence it has a premium valuation.

Similarly, Ulta Beauty trades at a much higher P/E multiple than others in its industry. The company sports a trailing P/E of 45.43, which can be considered quite massive when stacked against Macy’s 12.18, Nordstrom’s 15.25 and Sally Beauty’s 22.88. But, like Stephen said in the case of Whole Foods, Ulta Beauty is a better bargain because of its aggressive growth.

Analysts model a forward P/E of 29.28 for Ulta Beauty, which shows how fast the company is expected to grow. It’s not that the rest of its peers mentioned above aren’t slated for growth, but they are nowhere near the improvement expected of Ulta Beauty.            

Final words

With a strong history and signs of an even better future, Ulta Beauty is a stock that shouldn’t escape the attention of investors. The same was proved when money manager Steve Mandel’s Lone Pine Capital, which has outperformed the S&P 500 for a decade, acquired a stake in Ulta Beauty. And I think you might just do the same.

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