VladimirFLoyd/iStock via Getty Images Investment Thesis In my previous coverage of Ulta Beauty ( NASDAQ: ULTA ), I mentioned my surprise at the sudden downward revision in the cosmetics & beauty chain’s FY24 outlook that was expressed by management in a previous Retail RoundUp conference . The reason this downward revision caught me off guard at the time was because it occurred in a span of 2-3 weeks after the company set full year expectations in their disappointing FY23 earnings report . Since then, the company’s stock has fallen below the $408 level that I had estimated the company’s share price at, as seen in Exhibit A below.
Exhibit A: Ulta Beauty’s stock performance since the author's previous coverage (Seeking Alpha) In my current analysis of Ulta Beauty, I do not see any significant improvement since my previous coverage. Demand for the company's products has not picked up yet, while inventory levels appear to be relatively elevated but range-bound. However, I believe most of the pessimism in the stock now appears to be priced in based on my new estimates.
My analysis indicates the company’s stock will be range-bound for a few months, and I now recommend Ulta Beauty as a Hold while cutting my price target. Ulta Feels the Competitive Heat, Demand Still Elusive Ulta Beauty demonstrated its slowest quarterly growth rate ever of 3.5% y/y in Q1 FY24, if one ignores the FY20 year of pandemic lockdowns.
That revenue growth rate meant Ulta Beauty grew its total sales to $2.73 billion in Q1. The problem for Ulta at this point is the sales of its Cosmetics revenue segment, which contracted in the first quarter by 1.
2% to $1.14 billion. This is one important problem for Ulta to solve because the Cosmetics segment now accounts for a fourth of the company’s revenues and has been falling, as seen in Exhibit B.
In 2019, Cosmetics accounted for half of the company’s revenues. Exhibit B: Ulta Beauty’s Revenue Share across its Revenue Segments (Company Filings) When explaining further about possible reasons for the drop in cosmetics and make-up revenue, Ulta’s management explained this at a Growth Stock Conference, where they said the company was facing competitive pressure in the prestige beauty market, driven by weakness in their stores, ”in particular, makeup and haircare.” While Ulta Beauty operates across a range of price points, selling products to mass and prestige price points, it is still struggling to win back share & capture demand in the prestige beauty market.
In the Q1 earnings call , Ulta’s management called out the competitive pressures, saying “there are significantly more places to buy beauty, especially prestige beauty, with more than 1,000 new points of distribution opened in the last two years,” a strong hint to the 1,000 stores that were recently opened as a product of the partnership between LVMH-owned Sephora ( OTCPK:LVMHF ) and Kohl’s (NYSE: KSS ). What I did find encouraging is that growth returned to at least 2 out of 5 categories of Ulta’s beauty business: Fragrance and Skincare which grew by 15% and 8%, respectively. While new exclusive brands in Fragrance led to strong growth, the popularity of face masks and skin care in general helped in the strong sales of Skincare.
Inventory Levels Need More Improvement Inventory levels at the Bolingbrook, IL-headquartered beauty chain company are still high, in my view. My analysis of Ulta’s merchandise inventory levels from the company filings shows that inventory levels are showing some level of increase again per their Q1 FY24 10-Q filing , as shown in Exhibit C below. Exhibit C: Ulta Beauty’s Inventory levels are still showing elevated levels (Company filings) Per Exhibit C, Ulta Beauty’s merchandise inventory rose 8.
8% in Q1 to $1.91 billion, faster than the 3.5% growth in sales the company posted in the same quarter, indicating the company is having trouble moving inventory off its books.
On the Q1 earnings call, management said they “do expect that growth to normalize as we [they] progress during the year.” Until those inventory levels normalize, this will weigh on the company’s operating cash and eventually on its ability to generate free cash from the business. For Q1, the company’s unlevered free cash, which is estimated using operating cash and capex, dipped slightly below the billion mark to ~$914.
2 million. Exhibit D: Ulta's Shareholder Returns over time and in the trailing twelve months (SA & Company filings) The company also mentioned that they repurchased about 588k shares using $200 million of their $2 billion buyback program, leaving enough firepower to repurchase shares if the share prices fall further. Ulta’s Valuation Indicates Marginal Downside Management indicated some relative strength in the back half of the year, suggesting that while H1 of FY24 would still see low single-digit growth, H2 of FY24 would see low-mid single-digit growth, mainly due to newer brands being introduced and an easier comp if I see their performance in the back half of FY23.
In my previous coverage, I used a reverse DCF model to estimate Ulta’s price target given its low growth rates. I will continue to assume a 2% terminal growth rate, while my discount rate will be lowered to 8%, per estimates . Currently, markets appear to be pricing in ~4.
4% CAGR in Ulta’s free cash growth rate, down from the 5.5% growth rates I observed in my previous coverage. This is closer to the free cash growth rate I was and am expecting for Ulta.
At the time, I mentioned that I expect Ulta free cash growth rates to be in the 3-4% range given its outlook so far and consumer challenges that are singular to Ulta. Exhibit E: Ulta's valuation model shows there is marginal downside (Author) Assuming that Ulta grows in free cash at a 4% CAGR, that would imply Ulta’s shares to be fairly priced in the range of $365–$370, pointing to about a 5% downside from current levels. Risks & other factors to consider Watching inventory levels will be important at the moment since it will give management more room to optimize the free cash that it returns to shareholders.
Watching inventory levels and management commentary will also indicate any possible return in demand levels for the company’s products. For now, I expect the stock to be range-bound for a few months, at least until the company unveils their Analyst Day conference, which is still expected some time in October. No date has been provided yet.
Note: Ulta’s competitor and Sephora’s parent organization, LVMH, is scheduled to announce their H1 FY24 results on Tuesday, July 23 . Any major commentary about LVMH’s selective retailing business will move Ulta Beauty. Ulta Beauty is slated to report their Q2 earnings on August 29th after markets close.
Takeaway Ulta Beauty still looks to be facing some challenges in winning back customers in some of its revenue segments, especially in the makeup and cosmetics segment. Overall inventory levels also indicate the company is still seeing issues with moving inventory, putting pressure on its free cash. However, from a valuation standpoint, I believe Ulta will be range-bound for a few months, and I think with the company setting expectations for low single-digit growth for the rest of the year, the worst appears priced in.
I now recommend Ulta Beauty as a Hold. Editor's Note: This article discusses one or more securities that do not trade on a major U.S.
exchange. Please be aware of the risks associated with these stocks. Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole.
Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body..
