– Formerly high-flying ULTA  stock whacked for 2Q EPS miss, slowing cosmetics growth

– Plunge seems overdone; return to stable growth could push stock 20%+, in our view

– ULTA insiders (with prescient past timing) buying shares during the downdraft

Ulta Beauty Shares Whacked 35%; Stock Looks Cheap

What if the stock market had a rewind button? In other words, what if you had a chance to go back in time and buy the stock of a well-run, consistent growth company at a level once reached before it had a big run up? 

The shares of Ulta Beauty (ULTA), Chicago-based retailer of cosmetics, skin care and other personal products and services, could fit that bill. ULTA’s stock has been one of the best performers of the last decade. However, because of an earnings miss (Aug. 29) for the second quarter ending Aug. 3, ULTA shares were spanked hard, falling 35% in a few days.

Ulta Beauty Shares Whacked 35%; Stock Looks Cheap

The stock is down 1/3 to $252 from a recent high of $368.  The market is often tougher on the very companies with strong track records like ULTA, but this stock plunge seems like a long-term buying opportunity if, as I believe, ULTA can defeat its challenges.

Back in August ULTA’s earnings fell short of analysts’ forecasts. Worse, however, was that guidance was cut to 4%-6% same-store sales growth this year—a number most retailers would love—and down from prior expectations of 6%-9% and half what it posted from 2014 to 2017.  The cosmetics part of the business seems to be slowing.

Then too there’s a recent Piper Jaffrey survey suggesting that cosmetics spending by Gen Z consumers is down 20% this year. And even ULTA CEO Mary Dillon warned recently that the industry continues to be constrained in the make up category, that the headwinds are largely cyclical but also due to a lack of innovation.

Another ULTA headache—another one I think isn’t as bad as the market makes out—is that rival Coty (COTY) bought a 51% stake in Kylie Cosmetics, founded by lifestyle celebrity Kylie Jenner for $600 million. ULTA previously had exclusive access to some popular Kylie products. There’s some thought, too, that skincare products, 21% of ULTA’s total revenues, are growing at the expense of cosmetics, 51%.

In response, ULTA is upping its skincare brands offerings by 30 or so and expanding its multi-brand skin bar model into about 20% of its 1,200 stores. Customers can experience quick services, like a 10-minute express facial or a 20-minute mineral infusion. Not something you can get online.

Ulta Beauty Shares Whacked 35%; Stock Looks Cheap

I worry less about the celebrity following trends concern. They tend to be faddish and relatively short term. Undoubtedly, the future will see other celebrity-branded products that can outshine Kylie. Wall Street is down on the stock, with about 57% of analysts holding a Buy rating, the lowest since September, 2017, when the stock was about $200. ULTA caters to an important consumer need that might ebb and flow but isn’t going away. Everyone wants to look and feel good.

Investors shouldn’t ignore these potential problems, but I’d argue the stock price now seems to discount the headwinds and then some, giving ULTA and CEO Dillion little or no  credit for an ability to adjust. Already, the stock has recovered a bit after ULTA’s 3Q results (Dec. 6) were better than expected and it raised the low end of 2020 guidance.  

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Speaking of that quarter, the bullish JPMorgan analyst wrote approvingly that “management expressed a firm commitment to control expenses during the slowdown…. Barring a slowdown, we believe the ‘easy compare’ and ‘great company’ bull case should only strengthen with investors eyeing consensus for [calendar] 2020.” 

Additionally, ULTA’s Ultamate Rewards program is popular with consumers, allowing  customers to earn points based on purchases. It’s a strong incentive for repeat buying.  More than 95% of Ulta Beauty’s total net sales in fiscal 2018 were generated from the nearly 32 million active members.  The rewards program—and the consumer information ULTA collects—give ULTA a unique ability to capitalize on its vendor relationships.  In a recent report, Zack’s ranked its program as “…genius…one of the top [programs] in the retail business.”

Here’s another thing I like about ULTA: Insiders are buying, and not just any insiders.  Two with good track records—CEO Mary Dillon and direct Charles Heilbronn—have been buying shares since the stock plunged, says Jonathan Moreland, director of research at www.insiderinsights.com, which tracks insider activity. In fact, these two have been “pretty darn” prescient in the past both on buys and sells, and this buying, he adds, is a “stark reversal of opinion,” following shares sales earlier in the year.

Ulta Beauty Shares Whacked 35%; Stock Looks Cheap

If ULTA’s various corporate advantages—obscured by short term issues—allow it to fight back and regain its footing, the stock seems inexpensive. I won’t use the rearview mirror and don’t know if it will ever return to 20% plus growth, but that’s not necessary now. Plain double-digit percent EPS increases should be doable.

 The shares trade at 19 times consensus EPS of $13.23.  JPMorgan suggested the stock could return to the lower end of a 20-25 P/E, comparing ULTA’s situation to the big rebound in specialty retailer O’Reilly Automotive’s (ORLY) stock from two years ago, when the auto parts retailer faced an  Amazon-threat that turned out to be overhyped. 

There is no quick fix here, but if ULTA manages to stabilize its same-store sales, not only will EPS rise but the P/E could slowly expand back towards its 28 times historical average. The 3Q results suggest things aren’t as bad as the stock price would have it. It’s important that ULTA acknowledges the issues, half the battle in my view. This is a $14.6 billion market cap company with a return on equity of about 40% and effectively no debt beyond $1.7 billion in long term leases; with huge competitive advantages as the biggest U.S. beauty retailer. ULTA is buying back lots of shares.

It’s not a stretch to think that with some stabilization of growth, ULTA could earn $14-$15 in a year or two and get to a 22 times P/E, or a stock price of $308-$330, up more than 20%. I don’t think the cosmetics slowdown is secular, but you have to be patient as ULTA works through its issues over the next 12 months or so.

Where I could be wrong:  It’s possible that the cosmetics category mightn’t recover to previous growth levels. If ULTA can’t improve its game, then the stock could suffer.

Bottom Line:  A return to stable growth, even at a lower level, will invite investors back. In retail, store shelves still count.

Prior “Signals”

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Disclosures (show)

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