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Ulta Beauty 3Q18 earnings impress but guidance falls short

12 December 2018

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by Nick Dennis (Anchor Global Equity Fund)

US Beauty and cosmetics retailer, Ulta Beauty reported 3Q18 results on Thursday (6 December), which showed earnings topping consensus expectations although guidance was lighter than expected. Revenue stood at $1.56bn (+16.2% YoY), up from $1.34bn posted in 3Q17, while earnings (+28% YoY) came in at $131.20mn, or $2.18/share, up from $1.70/share in the year-ago period helped by the YoY fall in the tax rate. Same store sales (SSS) grew 7.8%, of which 3.4% was contributed by ecommerce, which now accounts for c. 11% of revenue. The company reported a significant jump in e-commerce sales, which rose by 42.5% YoY to $170.7mn, compared to $119.8m in 3Q17, while its salon sales also recorded double-digit growth, up 10.7% YoY to $74mn.

The gross margin was flat at 36.7% – flattered 50bps by an accounting policy change. Adjusted for this, the gross margin came under pressure, largely due to higher-than-expected discounting. Ulta has been updating its fragrance offering, and it took longer than expected to sell the old merchandise, so management took the decision to run more aggressive promotions. Operating profit grew 4% YoY to $169.2mn, or 10.8% of net sales, vs $162.7mn, or 12.1% of net sales, in 3Q17. Ulta’s operating margin, however, compressed as the company is investing in its Skin Bar offering, as well as growing in-store boutiques to support various prestige brands. We view these as growth investments (i.e. ‘good’ costs).

Our key takeaways were the following:

1.Ulta Beauty delivered a solid set of results; however, market participants may have anticipated stronger 4Q18 guidance, causing the shares to fall by 13% on Friday (7 December).

2. Gross margins came under pressure (discussed above) which probably contributed to the fall. This strikes us as a near-term issue and is not a thesis changer.

3. After a year of investing for growth, Ulta should see modest margin expansion over the next several years.

4. This, combined with double-digit revenue growth, should drive earnings growth in the mid-to high-teens range (consistent with management guidance). 

5. Ulta trades on a 20.5x PE (1-year forward), while its 5-year average PE is 28x.

6. Ulta could deliver an internal rate of return (IRR) in the high-teens to low-twenties range over the next few years (depending on the degree of re-rating).

CEO Mary Dillon described the results as “a strong performance”, reflecting “… continued market share gains across all major categories, acceleration in our overall comp driven by healthy traffic, excellent new store productivity, and robust e-commerce growth.”

Looking ahead, the retailer said it expects 4Q18 to follow a similar trajectory, with net sales in the range of $2.08bn, vs actual net sales of $1.9bn in 4Q17. Business Insider writes that the share price has rallied by c. 19% since 30 August when Kylie Jenner announced she would sell her cosmetic brand in Ulta Beauty stores during the US holiday shopping season.

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