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Remaining an investor in Ulta Beauty (NASDAQ:ULTA) has to be akin to playing Russian roulette. Prior to earnings the company was trading at nearly 28x next year's estimates of $3.14.

No indications exist that Ulta will have a massive blowup similar to fellow retailers Fossil (NASDAQ:FOSL) and Body Central (OTCQB:BODY) or any of the numerous stocks that plunged 20, 30, or even 40% during earnings. Of course, neither of those stocks showed signs of weak results ahead of plunges either. Considering Ulta trades at a lofty multiple, any whiff of disappointing numbers could result in a significant drop.

Good Enough

After the close on Tuesday, Ulta reported Q113 numbers that slightly exceeded estimates. Net sales hit $474.1M, which only slightly exceeded the $473M estimates. Earnings also beat by $.01.

Even though sales grew 23% with comp sales of 10.1%, the reason shareholders dodged a bullet was that beating expectations is crucial to maintaining the high valuations. Investors just aren't willing to pay up these days for strong results if it doesn't beat estimates. With Ulta only beating estimates by $1M on a $474M base, the company was very close to disappointing the market.

Downside Risk

Wrong or right this is the investor mindset these days. Fossil remains down 50% since the earnings meltdown back in early May. Body Central likewise remains down 50% since earnings. In both cases, next year's earnings have been trimmed in the 7%-8% range. Not a great risk/reward scenario for shareholders if a small cut leads to a huge outsized loss.

Don't get me wrong, Ulta is a superbly run retail operation with good growth potential. Analysts estimate that the 5-year growth rate will be around 25%. This makes the stock a potential great long-term buy at the right price. The key is the right price, which is likely lower.

More Stores

The company added 18 stores during the first quarter. This brings the total to 467 stores and square footage of nearly 5M, which represents a 19% increase in square footage.

The company announced an analysis that suggests the store plan for 10,000-square-foot models can be increased to 1,200 stores from 1,000. At existing store count, the future store growth potential is 157%.

Q113 Highlights

  • Net sales increased 22.8% to $474.1 million from $386.0 million in the first quarter of fiscal 2011;
  • Comparable store sales (sales for stores open at least 14 months) increased 10.1% compared with an increase of 11.1% in the first quarter of fiscal 2011;
  • Gross profit increased 110 basis points to 36.0% from 34.9% in the first quarter of fiscal 2011
  • Net income increased 49.7% to $34.9 million compared with $23.3 million in the first quarter of fiscal 2011
  • Income per diluted share increased 45.9% to $0.54 compared with $0.37 in the first quarter of fiscal 2011.

Guidance

The company currently expects net sales in the range of $466 million to $473 million, compared with actual net sales of $394.6 million in the second quarter of fiscal 2011. This assumes comparable stores sales increase 6% to 8%, compared with an 11.3% increase last year, which would result in a two-year comparable store sales increase of 17.3% to 19.3%.

Income per diluted share for the second quarter of fiscal 2012 is estimated to be in the range of $0.49 to $0.51.

Conclusion

Ulta remains a great run company, but investors won't likely be rewarded at the current valuations with this market. In a strong bull market, the stock could trade at valuations up to twice the 25% long-term growth rate. This just isn't going to happen now. The more likely scenario is that results eventually fail to live up to expectations.

Unfortunately Fossil and Body Central provided game plans for what happens in those scenarios. Investors dodged a bullet for now.

Disclaimer: Please consult your financial advisor before making any investment decisions.

Source: Ulta Beauty Shareholders Dodge A Bullet (For Now)