Ulta Salon, Cosmetics & Fragrance (ULTA) recently reported its sales for the 7-week holiday shopping from November 11 to December 29. Total sales for the period were $475.6 million, which was a 23.3% increase over the same period in 2011. ULTA maintained its guidance for the fourth quarter of sales in the range of $742-$754 million and EPS of $0.96-$0.98.
The market did not react well to ULTA's holiday sales, as shares fell more than 4% on the news. Because the stock trades with a P/E of 29 (based on expected 2013 earnings), ULTA is often mentioned as a short candidate. It may be tempting to short the stock here given the market's reaction to the holiday sales. But the numbers indicate that a short position right now is premature. There is a better alternative if you want to play ULTA safely through Q4 earnings and beyond.
Fourth Quarter Earnings Should Meet or Beat Estimates
ULTA's holiday sales have been a good predictor of the company's Q4 revenues. Historically, the holiday sales have accounted for 65%-66% of total revenues. This year, that would mean about $725 million for the quarter.
At first glance, that looks like a big miss. But you need to remember that this year Q4 has an extra week. Accounting for the extra week, however, is not as simple as pro-rating the daily sales for the holiday period. The daily sales during that 7-week period are much higher than the daily sales during the non-holiday period. In fact, over the past four years, the non-holiday daily sales are about 59%-60% of the daily holiday sales. Using these historical relationships, the projected Q4 revenue for ULTA should be approximately $758 million. My model also projects earnings around $1.02. That exceeds the guidance provided by ULTA, and also exceeds street estimates of $751.68 million and $0.98.
Price Should Move Up In Reaction to Earnings
For many high-growth stocks, revenues and earnings are typically expected to surpass conservative street estimates by a wide margin to push the stock up after earnings. But that has not been the case for ULTA. In the first three quarters of 2012, ULTA beat the street by the same margins projected above and the stock reacted positively each time.
For example, in Q1, ULTA barely met revenue estimates and beat earnings estimates by a cent. In response, the stock jumped over $7. In Q2, ULTA beat revenue estimates by $7 million and earnings by three cents, which resulted in a $6 move up. Likewise, in Q3, ULTA beat by $2 million and 3 cents, which moved the stock up $7.
A similar move is shaping up here. Given recent history, ULTA could very well see a $5-$7 pop after it reports earnings based on the Q4 results.
Guidance Should Be In Line with Current Estimates
ULTA provides guidance for the next quarter in each earnings release. Based on how the numbers are shaping up for Q4, my model projects revenues around $589 million and earnings of $0.74 compared to street estimates of $579 million and $0.72.
ULTA typically exceeds estimates by a significant margin, which explains some of the positive price action after earnings. While It is not possible to predict what guidance ULTA will provide, it appears that the numbers may slightly exceed expectations. This may hold back the upward movement in price a bit, but it does not signal a drop.
In the longer term, it does not look like ULTA will be able to maintain the 20+% year/year growth it has achieved in the past three years. A look inside the numbers shows that ULTA's year/year sales/store has been steadily declining. If the effects of the extra week are removed from this quarter, sales/store growth has nearly stalled as shown in the chart below.
ULTA claims that it can grow to more than double the current number of stores (which was 537 at the end of Q3). Even if that's true, the location and sales potential of new stores is typically worse than that of existing stores. That likely explains much of the drop we see in the year/year growth of sales/store in the chart above.
As it currently stands, my models value ULTA at around $84 given its current growth rate. With such a high multiple, the stock could fall sharply if there is a hint that overall revenue growth may stall. Thus, ULTA will be ripe for a short position in the very near future. Patience here is key.
Trading Strategies for ULTA Through Q4 Earnings & Beyond
With ULTA projected to beat on the top and bottom line, all signs point to a move up for earnings. The wild card will be guidance--and this time around it might not be enough to please investors. As a result, there is considerable risk with both a long and short position in the shares. In the last three quarter, the price has moved $6-$7 after earnings. That means it could be painful if you are on the wrong side of the trade.
A calendar spread provides an alternative strategy that allows you to reduce your risk, but also participate in an eventual drop in price. ULTA is scheduled to report earnings after February options expire, but before the March option expiration. If you want short exposure to ULTA for earnings, you can write the February 95 puts for $2.35 and then buy the March 95 puts for $4.30. The trade costs $1.95 per share (and that is the most you can lose with this strategy). The goal here would be to have ULTA trade higher than $95 at the February options expire worthless. At that point, you will hold the March 95 puts and will be positioned to exploit a move down below that price after earnings.
If you believe that ULTA's price will remain strong after Q4 earnings based on the projected beat, but want to play a drop for Q1 earnings, you can use the same strategy with the March and June options. Because of the increased time period between the two options, the cost for this trade is $3.50. In this scenario, you would be betting that ULTA stays neutral or moves up after earnings, but will decline before the June options expire. Note that ULTA will likely report Q1 earnings in early June before expiration.