Ulta Continues Strong Growth But It Is Extremely Overvalued

| About: Ulta Salon, (ULTA)

Beauty retailer Ulta Salon (NASDAQ:ULTA) reported strong second quarter results. Revenue grew 22% to $486 million, slightly higher than consensus estimates. Earnings per share also exceeded estimates, growing 42% year-over-year, to $0.54 per share. The firm increased its full-year earnings guidance to $2.58-$2.60, higher than the consensus of $2.55.

There was much to like about Ulta's second quarter, namely its 9.3% same-store sales growth. Increased spending contributed 300 basis points to the measure, while 600 basis points came from higher traffic. Gross margins also expanded 300 basis points year-over-year to 34.8%, indicating a better pricing environment. The company also opened 22 new stores during the quarter as it embarks on a massive expansion plan, which calls for a total of 1,000-1,200 locations nationwide.

Given the firm's continued momentum and successful concepts like Clinique boutiques and Lancome, we think the company is stealing share from the traditional mall-based make-up and fragrance departments at department stores. We currently see no signs of the retailer's growth slowing, and neither does the company. Management forecasts full-year same-store sales growth of 8%, and it expects to generate positive free cash flow-an impressive feat for a relatively capital intensive business.

Despite the strong quarterly performance, we think the firm is overvalued at current levels. Shares score a 1 (the worst measure) on the Valuentum Buying Index (our stock selection methodology), suggesting an unfavorable view of its upside potential on the long side. However, we're not rushing to add a synthetic short position (put option) to our Best Ideas Newsletter portfolio either, because we have no reason to doubt the firm's execution at this time. The stock might be overvalued, but the firm generates cash, carries no debt and its business model remains sound.

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