1. Is the company undervalued?
EV/EBIT: 17.3
Price/Sales: 2.53
Price/Book: 10.05
$ULTA is a highly profitable business, which has grown at an above market rate historically. Moreover $ULTA is a free cashflow machine and management has returned the lion’s share of those profits back to shareholders. If $ULTA can maintain growth, investors could realize outsized returns in the future.
2. Can I easily explain what the company does?
Yes, they’re a beauty retailer who sell cosmetics, fragrances, haircare, and skincare products primarily.
3. Does the cash flow statement line up with income statement?
Yes, cashflows have on net been higher than reported earnings:
Almost all of their excess cash went towards share repurchases and capital expenditures, which I’m A-OK with.
4. Is the Balance Sheet Healthy?
Total Debt: 1.84B
Total Cash: $605M
Current Ratio: 1.75
$ULTA holds minimal debt relative to their market cap and they pay effectively nothing in net interest payments annually. This coupled with strong free cash flow generation gives Ulta an impressive balance sheet grade of A-.
5. How profitable is the business?
Gross Margins: 38.42%
Operating Margins: 14.31%
Net Margins: 10.72%
ROIC: 22.85%
$ULTA is without question a quality business, which has exhibited fairly consistent profitability:
While $ULTA doesn’t offer investors software like margins, the company is certainly above average and significantly superior relative to other retailers.
6. What is the company’s growth potential?
10-yr Revenue CAGR: 15.5%
10-yr Operating profit CAGR: 16.37%
10-yr FCF CAGR: 32.31%
Ulta has posted incredible growth over its history. Unfortunately, the business model is near full saturation with 1,296 stores open currently. Furthermore the pace of store openings have slowed dramatically. For instance the company only opened 6 net new stores in the past two quarters.
It’s extremely unlikely $ULTA grows at double digits in the future as evidenced by analysts forecasting ~6% topline growth moving forward. Having said that mid-single digit growth is about what the market does historically, so really not the worst given $ULTA present valuation.
7. Is management rewarding shareholders?
$ULTA doesn’t offer a dividend, although they currently have $760M left on their share program. Moreover management has returned most off their profits back to shareholders via buy backs. For example $ULTA had operating profits of ~4.6B over the last 5 years and repurchased over $2.6B in stock during the same time.
Buybacks certainly aren’t the sexiest use of cash, but unlike Justin Timberlake I’m not trying to bring sexy back (ROFL COPTER). If you assume $ULTA continues returning 50% of profits back to shareholders, then investors would be looking at a ~3% total shareholder yield (backing out stock-based compensation).
8. How does the company stack up against their peers?
The closest competitor to $ULTA is Sally Beauty Holdings Inc. $SBH:
$SBH Price/Sales: 0.43
EV/EBIT: 8.54
Net Margins: 6.56%
While $SBH trades at a deeper discount, it’s objectively a much shittier business. For example revenues have declined since 2016 and the company holds significantly more debt. Furthermore $SBH and $ULTA return roughly the same back to shareholders every year. $SBH has all the makings of a melting ice cube and the valuation discrepancy isn’t nearly wide enough to justify the investment in favor of $ULTA.
9. What’s the counter argument?
The counter argument is that competition is entering the space and profitability will be adversely impacted moving forward.
Intuitively this makes sense to me given that $ULTA is a high margin business with effectively zero moat. Candidly I never even hear of Ulta Beauty prior to doing this write up. Additionally they have limited propriety products, so I fail to understand why Amazon couldn’t undercut their prices by 10% and steal market share. However I’m by no means their target demo, so perhaps there’s some nuance I’m missing here.
10. Is there something I think the market may be missing?
$ULTA seems fairly valued in my opinion given their growth prospects. With that said revenues could surprise to the upside considering Ulta’s historical performance. Although there would have to be a pivot in their business model to hit double digit growth ie; international expansion, new white label products, etc…
Final Thoughts:
My base case for $ULTA would be 6% EBIT growth annually, a 3% total shareholder yield, and a 15X EV/EBIT exit multiple in 5 years. This is only a 6.2% expected return, which is quite underwhelming. Nonetheless these assumptions could prove to be too conservative, but I prefer to err on the side of caution. Additionally I could see a scenario where $ULTA turns into a no growth low profitability retailer in the future. For these reasons it’s a pass for me and something I likely won’t revisit unless it hits a single digit multiple.
***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours. This article is intended for educational purposes only and in no way should be interpreted as investment advice