Brett_Hondow Ulta Beauty (NASDAQ:ULTA) has been one of the worst-performing stocks in the S&P 500 in 2024, as the company continues to lose market share and struggles to improve profitability. And yet, investors and analysts think that Ulta is a clear bargain because it was once a compounder trading at a 30x multiple. Investing isn’t that easy, so let’s revisit the reasons for Ulta’s demise. Only then we can judge if it’s, in fact, an attractive buy-the-dip opportunity. Revisiting My Previous Buy & Hold Changes I started covering Ulta Beauty on Seeking Alpha back in October 2023, naming the company a pure value play. Two months later, following a 25% increase in stock price, I downgraded the stock, saying that it was no longer a value play. I have to say, I don’t think I’ve ever timed an investment so perfectly. Data by YCharts In October, Ulta was going through a sharp selloff, caused by temporary headwinds that included shrinkage and supposedly temporary cost inflation. In addition, management guided for a significant deceleration, citing a tougher beauty market. As I wrote then, these “temporary” headwinds weren’t enough to justify as harsh of a selloff, and I thought that management prepared investors for much worse than what was going to happen. In addition, Ulta had two potential catalysts, in UB Media and an international expansion, that I believed were not reflected in the stock. Time went by, and several things became clear. One, the UB Media business is very far from becoming anything material. Two, the company’s international plan is going to be passive and slow. As a result, I downgraded the stock to a Hold, although I said many times that I would sell it if it was in my portfolio. Now, as the stock is back at October levels, it’s time to revisit Ulta’s situation. Continued Underperformance In Q1’24 Ulta started the year with consensus estimates sitting at revenues of $11.73 billion, and EPS of $26.8. Today, the consensus is at $11.56 billion and $25.77, respectively. The significant downgrades are primarily a result of management’s commentary throughout the year, as well as its lackluster Q1’24. Ulta Beauty Q1’24 Earnings Release In the first quarter, Ulta saw revenue growth of 3.5%, driven by a 1.6% increase in comps, and a 1.9% contribution from new openings. For comparison, LVMH’s (OTCPK:LVMHF) Selective Retailing segment, which is primarily Sephora, had organic growth of 11% in the period, reflecting significant market share losses. Gross margins declined by 80 bps, as the company is doing heavy discounting seeking to maintain market share. Operating margins declined by 210 bps compared to the prior year period, due to higher corporate overhead for strategic investments, higher store payroll and benefits, and higher store expenses trying to mitigate theft. As a result, net income declined by 9.8% Y/Y, reflecting a 170 bps contraction in profit margins. One major worry I have is regarding the company’s operating cash flow, which declined by 48% Y/Y, due to a combination of the net income decrease, and the company’s inventory building much faster than revenues. Increasing inventories are one of the biggest red flags in retail. Historically, the first quarter is one of the company’s stronger quarters in terms of cash flow generation, and this should be monitored very closely. Overall, this was a bad quarter all around, and what’s more worrisome is that some peers are delivering great results. Putting Ulta Beauty’s Historical Multiple In Context As the title of the article suggests, I view the historical multiple thesis as flawed when it comes to Ulta. I do rely on historical valuations in my analyses, but it’s crucial to focus on the context as well. If a company isn’t growing as fast as in the past, its margins are contracting, and its growth trajectory isn’t as attractive, well, it shouldn’t trade at the historical multiple. Data by YCharts The above graph shows us Ulta’s TTM multiple over the past decade. We can see that today’s 14.8x marks a low point, with the company trading in the 20x-30x range post-pandemic, and as high as 30x-40x pre-pandemic. The 5-year average for Ulta is in the 28x range. This leads many investors and analysts to the simple conclusion that Ulta is undervalued. Allow me to ruin the party. Created by the author based on data from Ulta Beauty’s financial reports. The above graph shows three primary drivers for Ulta’s stock performance between 2016-2024. We can clearly see growth sharply decelerating while operating cash flow margins decline to decade lows. And to those who might argue this is due to temporary issues, please look at the following graph: Created by the author based on data from Ulta Beauty’s financial reports. Ulta used to be a story of high-single-digit comparable sales growth, combined with an extremely aggressive and successful footprint expansion. As the company approaches 1,500 locations in the U.S., the geographic expansion story is no longer that attractive. In fact, it might be reaching a cannibalization period, as reflected by the decelerating comp growth. Moreover, the beauty industry has transformed quite rapidly. It’s much more fragmented, as social media influencer and celebrities are building their own brands. Many of them rely on direct channels, rather than wholesalers, to sell their products. The competitive landscape has changed as well, with players like Amazon (AMZN) taking significant market share, especially in the replenishment business (meaning that when a beauty shopper runs out of her day-to-day product, she’ll buy it on Amazon rather than go to the store). So, I hope I’ve been able to establish that Ulta Beauty does not deserve its historical multiple. The question is, what multiple does it deserve? Valuation & Price Targets Based on Ulta’s current guidance, the company’s EPS in 2024 is expected to be $25.6. That’s slightly below consensus, which is at $25.8. This puts Ulta at a north below 15 times earnings. Data by YCharts Unlike previous articles, Ulta is not at the bottom of the peer group we look at for specialty retailers. This is already a more comfortable entry level, especially considering beauty is probably the most resilient market in this group. However, I argue that none of the other names in the above list are dealing with the same problems that Ulta does when it comes to competitive disruption. Created and calculated by the author based on Ulta’s financial reports and the author’s projections. Assuming 5% revenue growth, which is at the high end of the beauty market growth range, and a slow recovery to historical margins, I expect Ulta to grow its free cash flow at a 7.5% CAGR until the rest of this decade. Taking a WACC of 8.8%, my price target for Ulta is $402 a share, reflecting a 5.0% upside, or a fair multiple of close to 16 times earnings. Conclusion Relying on Ulta’s historical multiple as an investment thesis is a mistake, in my view, as the context is undeniably different. This is no longer a story of double-digit growth, rapid footprint expansion story, and margin expansion. Rather, this is a story of a company in need of a turnaround, with an underwhelming growth trajectory and increasing inventories. Therefore, I view the sharp decline in share price as justified and reiterate a Hold.
sekar nallalu Cryptocurrency,ULTA,Yuval Rotem Ulta Beauty: Rising Inventories Are Another Major Red Flag (NASDAQ:ULTA)