Can ULTA's Defensive Product Line Stand Against This Down Cycle
When Gillette came out to provide the men's marketplace with a reliable grooming solution, many failed to realize that this one product line would fall swiftly into the category that investors today call 'defensive,' as characterized by low cyclicality and volatility coupled with an underlying steady need for the products themselves.
Having taken significant market share and brand recognition within its desired audience, Gillette's demand had nowhere to go but upward. As a result, Procter & Gamble (NYSE: PG) acquired the company as it played a turnkey role in its more extensive portfolio of other defensive product lines, adding to the non-cyclical nature of the company's financials.
As grooming remains an entrenched part of everyday life, so have become other areas of the self-care sector. ULTA Beauty (NASDAQ: ULTA) is now an entrenched brand recognized by virtually every American who understands what it's like to have a skincare routine or simply a 'get ready' routine before going out or to the office. As markets initially failed to recognize Gillette for the defensive properties it possessed, it is reasonable to believe that ULTA's beauty products are underserved by today's investment community as defensive and deeply entrenched as well.
The Answer in the Numbers
As ULTA reports its first quarter 2023 earnings results, its press release makes clear just how resilient the underlying fundamentals of ULTA's financials are. During a year when inflation reached a nearly 50-year high rate of 8%, ULTA's top-line revenue advanced at an even faster pace, showcasing not only pricing power over its consumers but also the ability to pass on input costs due to its loyal following. Retail analysts look for one metric to begin the formation of their opinions of a company; that metric is comparable sales growth or declines, regarded as a critical key performance indicator (KPI) in any retail business.
This measure comes in on Thursday during the after-market evening hours for ULTA to surprise investors with a 9.3% growth rate. Posting $2.6 billion in sales and diluted earnings per share of $6.88 compared to analyst expectations of $6.82, blowing past by a hefty 0.87%, was enough to send the stock flying on a new rally. Except, the opposite happened.
Shares of ULTA traded lower by as much as 7.4% in the after-market session, despite beating expectations and growing sales beyond any reasonable inflationary concern. This price reaction may come after short-term traders unload based on their high hopes of double-digit growth in sales.
The first quarter of 2022 posted comparable sales growth at an 18% clip, declining virtually by half a year later may have upset some hot-hand bettors, believing that what has happened in the past will continue to occur into the future. Nonetheless, margins and other performance metrics showcased current management's ability to navigate the challenging economic environments seen today.
Despite product inflation and other significant increases in input costs, gross margins only declined by 0.1% to end the quarter at 40.0%, not enough of a contraction to justify the price sell-off. Operating margins did see a more significant decline, going from 18.7% in 2022 to close this period at 16.8%; management attributes these declines to its restructuring efforts within its stores.
As SG&A (Selling, General, and Administrative) expenses increased, management reassures investors that the trend is due to the deleveraging efforts to reduce overhead, payroll, and other benefit expenses. Of course, closing a personnel gap requires incentives for newer, more efficient workers; compensation expenses were allowed a bump.
Buy the Dip?
Are bears right in this case? It is not likely, as these margin reductions resulted from a long-term value creation roadmap. Net income was also affected by an unexpected increase in interest income of $7.3 million; despite 2022 being covered in rate hikes on the part of the U.S. FED attempting to battle inflation, bulls will celebrate the added $0.15 per share income stemming from this bump, while bears will protest and say it is a non-recurring item and therefore should be discounted. The fact of the matter is that management expects another $17 million or so in interest income for 2023, so Bulls win this one.
Today's sell-off has brought the company's valuation to a decade-low (excluding COVID-19 sell-offs), sporting a 20.2x price-to-earnings ratio. Historically, ULTA stock has traded within the 28.0x to 33.0x multiple ranges. Some will begin to call for overvaluation at these rich ratios but forget that other defensive companies like Colgate-Palmolive (NYSE: CL) also host P/E ratios above 30.0x, thanks to their high quality of earnings.
In addition, ULTA analyst ratings agree that the stock may be lower than its fair value, as they have assigned a 15.4% upside from today's prices; management has also approved a further $900 million share repurchase program even after already buying back $285.8 million in stock during the first quarter. The new buyback program will represent nearly 4% of the company's market capitalization, conveying that insiders believe the stock is cheap.