Retailer of beauty and cosmetic products Ulta Beauty (NASDAQ:ULTA)The share price performance has not been very positive over the last six months. Slowing growth and falling profit margins have caused the stock price to fall; the stock has fallen from almost $600 to less than $400 in just the last six months.
Although the stock has had reason to fall, the stock market is often overzealous. There’s a strong argument that Ulta Beauty’s sale happened too farand stocks are poised for a strong rebound. Here’s why Ulta Beauty is a great buy for investors right now.
Why did the stock drop so much?
Beauty and cosmetics are cultural staples, not only in America, but around the world. Ulta Beauty is the largest cosmetics retailer in the United States, with 1,395 stores and an online store. It sells tens of thousands of products from hundreds of brands. Ulta has also become a brand in its own right; the company engages with its customers through social media and loyalty programs.
Ulta had just 449 stores in 2011. The steady opening of new stores has fueled relatively uninterrupted sales growth for years outside of the pandemic, hurting virtually every business with brick-and-mortar stores. Consistent, profitable growth has made Ulta Beauty a market leader; the stock outperformed the S&P 500 approximately 3 to 1 since the company was founded Initial Public Offering in 2007.
Consumers were flush with cash thanks to the pandemic, which boosted Ulta’s business. However, those tailwinds have faded. Sales growth has steadily slowed since peaking in 2021, while gross profit margins peaked at the end of 2022:
Management has blamed increased theft and low-margin sales for the margin pressures. It makes sense; consumer savings rates have fallen below pre-pandemic levels. Naturally, a retailer will struggle if shoppers have less money and are turning to cheaper brands. Even as people try to maintain their beauty routines, cosmetics ultimately remain a discretionary budget item.
It’s not so bad
The good news is that Ulta Beauty’s formula for success has worked for many years and there’s not much reason to believe it won’t continue.
The company continues to open new stores and renovate existing locations. Management expects 60 to 65 new store openings in 2024 and another 40 to 45 renovations. The new stores will increase the total number of locations by 4% to 5%, essentially generating low-single-digit revenue growth.
Renovations and a possible recovery in consumption are expected to boost sales at existing stores. Analysts estimate that Ulta Beauty’s annual revenue growth will average between 5% and 6% over the long term.
Ulta Beauty’s margin declines aren’t necessarily a reason to panic. Current gross margins of 38.9% are still significantly higher than pre-pandemic, when Ulta’s margins were around 36%. The company’s free cash flow is still a short distance from decade highs, which should continue to fuel future share buybacks. It has reduced its share count by 26% over the past decade, helping to drive earnings per share growth.
Ultimately, investors need to determine whether Ulta Beauty can continue to generate long-term growth. There’s nothing here to suggest it can’t.
The sale went quite far
The market has sold off Ulta Beauty stock aggressively in recent months, and the stock has become cheap. The company has averaged a price-to-earnings ratio of 32 over the past decade. Today, Ulta Beauty trades at just 15 times its estimated 2024 earnings — less than half its average long-term valuation.
It would make sense that Ulta Beauty’s business would be badly damaged, but that doesn’t seem to be the case, as we’ve seen. Additionally, analysts are optimistic and expect the company to grow earnings by an average of more than 12% per year over the long term.
There is a famous saying that the stock market can sometimes be irrational. This saying works both ways, meaning stocks can become extremely expensive or cheap, depending on the whims of Wall Street. Ulta Beauty fell out of favor and the market used legitimate short-term hurdles to sell the stock out of sight.
The stock is a bargain at this price, making it an attractive buy for long-term investors willing to wait for these challenges to abate.
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Justin Pape has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Ulta Beauty. The Motley Fool has a disclosure policy.
This market-beating stock is a great buy right now was originally published by The Motley Fool
