Ulta Salon - Solid Results, Yet Steep Valuation Leaves Little Margin Of Safety

| About: Ulta Salon, (ULTA)


Ulta Salon beats estimates in a weather-challenged quarter.

Growth potential remains as the company targets 1,200 US stores.

The valuation already reflects all the good news, creating no margin of safety.

Ulta Salon, Cosmetics & Fragrance (NASDAQ:ULTA) reported a solid set of first quarter results on Tuesday following the market close.

Investors are pleasantly surprised by the strong results in a challenging quarter given the harsh weather. The reiteration of the full year outlook provides comfort as well. That being said, I believe shares offer no margin of safety, trading around 25 times forward earnings.

This is the major reason why I continue to shun the shares.

First Quarter Headlines

Ulta Salon reported first quarter revenues of $713.8 million, which is up 22.5% on the year before, and came in ahead of consensus estimates, which stood around $700 million.

Reported net earnings were up by 19.4% to $50.0 million.

As a result of very modest dilution in the shareholder base, earnings were up by 18.5% to $0.77 per share thereby beating consensus estimates by three cents.

Looking Into The Results

Headline results were very strong driven by an 8.7% increase in comparable sales growth, which accelerated from a reported 6.7% rate in the first quarter of last year.

120 net new store openings over the past year explained the remainder of revenue growth. E-commerce sales were up by 72.3% thereby adding 190 basis points in comparable store sales. This represents roughly an $11.1 million increase in e-commerce sales, which implies that e-commerce sales were roughly $26 million for the quarter, or around 3-4% of total sales.

The company saw pressure on gross margins which contracted by 50 basis points to 34.5% of sales. Margin contraction was driven by a changed channel as well as product mix. The conversion of loyalty members to the ULTAmate Rewards program pressured margins as well.

Selling, general and administrative expenses were unchanged at 22.8% of sales as operating income fell by 30 basis points to 11.3% of sales. The company managed to lower pre-opening expenses after opening 21 new stores during the quarter, down from 28 net openings in the first quarter of last year. The company currently operates 696 stores.

Looking Into The Second Quarter, Reiterating The Outlook

For the second quarter, Ulta Salon anticipates sales to come in between $706 and $717 million, driven by a 5 to 7% increase in comparable sales. Earnings are seen between $0.78 and $0.83 per share.

For the entire year, Ulta foresees a 4 to 6% increase in comparable store sales, while opening a 100 new stores. Total sales are seen up in their mid-teens, which would translate into revenues of around $3.1 billion.

Earnings per share are expected to grow in their mid-teens as well, which would translate into earnings of $3.62 per share assuming a 15% jump in earnings per share.

Valuing Ulta Salon

The company ended the quarter with $456.7 million in cash and equivalents while the company has no debt outstanding. The company does however hold $531.4 million in inventories, which rose by roughly 20%, thereby trailing topline revenue growth.

At $94 per share, the company is valued around $6 billion, which values operating assets at roughly $5.5 billion. This values operating assets at 1.8 times expected revenues for this year and 25-26 times annual earnings.

Ulta Salon does not pay a dividend at the moment.

Long-Term Growth

Ulta Salon's future assumes a continuation of growth with the company seeing potential for 1,200 US stores, being the leading retail concept in a large but fragmented market.

This compares to 696 stores being operated at the moment, and if Ulta could meet this target this could translate into revenues of around $6 billion per annum. This assumes that Ulta Salon could boost revenues per store by 25% in five year's time, while opening a 100 stores per year until the end of the decade.

At that point in time, earnings of $450 million would be anticipated given the margins reported at the moment. This does however leave upside for potential operating leverage. Fortunately, for investors, the company's business model is asset light.

Capital expenditures are minimal at roughly $1 million per new store as the payback time of a new store is as little as two years.

Takeaway For Investors

The targeted growth plan looks appealing, but potential revenues of $6 billion per year, and a price earnings ratio of 10-12 are still at least 5 years away in time. This assumes that a lot of things have to continue to go well, including store openings and a solid pace of comparable store sales growth.

Crucial in this growth path will be the loyalty program of the company with its 13 million members generating 80% of total sales at the moment. Note however that Ulta Salon targets above-average income households, which makes the company quite vulnerable for an economic setback.

Trading at 25 times forward earnings, shares continue to price in a lot of continued and profitable growth, making shares still vulnerable for a setback or unexpected nasty surprise.

Back in December of last year, I advised investors to shun shares after they saw a big sell-off in the wake of the latest results at the time. Ever since, the company has seen continued growth, which has increased valuation appeal, yet these improvements are not enough to justify picking up some shares at current levels in my opinion.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.