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Shares of Ulta Salon, Cosmetics & Fragrance (NASDAQ:ULTA) jumped sharply upwards on the final trading session of last week. The beauty retailer reported solid second quarter results accompanied with an upbeat outlook for the remainder of the year.

After a 50% run-up over the past six months, following a soft earnings report accompanied with the CEO departure, I remain on the sidelines. While 25% earnings growth year-on-year is spectacular, I am put off by the valuation at 33 times annual earnings.

Second Quarter Results

Ulta Salon generated second quarter revenues of $601.0 million, up 24.8% on the year before, thereby comfortably beating consensus estimates of $588.4 million.

Net income rose by 28.3% to $44.9 million. Diluted earnings per share rose by 29.6% to $0.70 per share. GAAP earnings beat consensus estimates by three cents.

CEO Mary Dillon commented on the second quarter performance, "The Ulta Beauty team delivered a very strong quarter while moving our growth strategy forward. Ulta Beauty added several new brands to its stores; we further expanded the number of Clinique and Lancôme boutiques; we drove rapid growth in our e-commerce business; and we achieved record membership in our loyalty program. I am incredibly excited about the future potential of Ulta Beauty, and I look forward to working with the team to build on the solid foundation they have built."

Looking Into The Results..

Sales growth was driven by store openings, but the 8.4% increase in comparable sales was quite solid as well. Note that this includes e-commerce sales, which were up by 72%.

Gross margins rose by 50 basis points to 35.3% of total sales. The company benefited from sales growth leverage, as well as disciplined promotions and occupancy leverage.

Selling, general and administrative expenses rose by 40 basis points to 22.4% of total sales. The expansion of brand boutique stores and labor investments to support prestige categories are putting upwards pressure on costs.

As such, operating income rose by 26.8% to $73.9 million. Operating margins rose by 20 basis points to 12.1% of total sales.

..And The Remainder Of The Year

For the current third quarter, sales are seen between $613 million and $623 million. At the midpoint of the range, this is up 22.2% on the year before. Comparable store sales are expected to increase between 5 and 7%.

Net earnings are seen between $0.71 and $0.74 per share, up 23% at the midpoint of the range. Analysts were looking for third quarter earnings of $0.76 per share on revenues of $618.7 million.

The company reconfirmed its full year outlook for 2013. Ulta Salon sees 5 to 7% growth in comparable store sales, and 125 net new store openings. Earnings per share growth are seen at the low end of the 25-30% growth target.

Valuation

Ulta Salon ended the quarter with $286.2 million in cash and equivalents. The company operates without the assumption of debt, for a solid net cash position.

For the first six months of the year, Ulta Salon generated revenues of $1.18 billion, up 24% on the year before. Net earnings rose by a similar percentage towards $86.7 million. Full year revenues could come in around $2.6 billion, as earnings per share could come in around $3.35, or $215 million.

Factoring in gains of 17% in Friday's trading session, with shares exchanging hands at $117 per share, the market values the company at $7.5 billion. This values operating assets of the firm at $7.2 billion, or 2.8 times annual revenues and 33 times annual earnings.

Ulta Salon does not pay a recurring normal dividend at the moment.

Some Historical Perspective

Shares of Ulta Salon were sold to the general public at $18 per share in October of 2007. After jumping to levels in their thirties on their first day, shares steadily fell to lows of $4 in 2009. From that moment in time, a steady recovery sent shares to $100 per share in 2012, while the latest earnings report results in fresh all time highs around $118.

Between the fiscal year of 2009 and 2012, Ulta Salon has increased its annual revenues by a cumulative 81% to $2.22 billion. Net earnings more than quadrupled to $172.5 million over the past year.

Investment Thesis

Ulta Salon keeps on showing rapid growth with a combination of rapid new store openings, and comparable store sales growth which was driven by new products at existing stores. During the quarter, the company opened 33 stores, ending the quarter with a store base of 609 stores. The continued investments in new stores and expanding categories drove a 45.6% increase in inventories, which stood at $461.2 million at the end of the quarter. Notably the opening of prestige boutiques contributed to this build-up.

For the long term, the company has a target of 1,200 stores, representing roughly a doubled store count from the moment. Investors are relieved, given a disappointing reaction earlier this year, as shares fell from $100 at the start of the year to lows of $75 in March. Shares have recovered since, and are now trading with year-to-date gains of 20% at $117 per share.

Investors are happy that under command of incoming CEO Mary Dillon, the operational performance seems to be continued, although she has only been on the job for two months. A key priority for her is to drive brand awareness, thereby boosting comparable sales. A key part of this is the loyalty program, which now has 12 million members, and the opening of boutique stores from Clinique and Lancome.

For this year, the company expects to open 125 stores, making a 1,200 store target reachable within five years. The company notes that the current pace is putting some stress on the organization though, especially as the company has 53 openings planned for the third quarter.

Back in March of this year, I last took a look at Ulta Salon's prospects. I concluded that the uncertainty regarding former CEO Rubin's departure and a growth slowdown has weighted on shares. These factors, combined with a build up in inventories, made some investors, including me, a bit skeptical.

In hindsight, this was a bit too pessimistic. In the meantime, the company has found a new CEO and has seen solid operating performance which has triggered a 50% recovery in the shares. While I might have been a bit too concerned about the developments back in time, the recovery over the past six months has been strong, especially after the second quarter earnings report.

While the long term fundamentals are intact, I refrain from making an investment at 33 times earnings, despite the long-term earnings growth trajectory of 25%.

Source: Ulta Salon: The Stock Has Become Too Beautiful After Recent Momentum