Ulta Beauty Inc. (ULTA, Financial) has gained roughly 9% following its third-quarter operating performance, surpassing Wall Street's expectations. The company has delivered decent gains despite some fluctuations over the past decade. The share price has surged by over 376%, equating to a compounded annual growth rate of 16.9%. In this discussion, I will analyze Ulta Beauty to see whether it is a good stock for investors at the current price.
Significant footprint with a lot of room for potential growth
Ulta Beauty is as a major player in the specialty beauty retail sector with over 1,350 stores across the United States. These stores offer a wide range of products, including fragrances, cosmetics and skincare items, along with a suite of services such as full-service hair salons, brow bars, makeup and skin treatments. The company holds approximately 9% of the $104 billion beauty product market, but only a 1% stake in the $68 billion market for hair, skin and nail services. This disparity highlights significant opportunities for Ulta Beauty to expand its services segment and increase its market presence.
Third-quarter results beat analysts' estimates
In the third quarter, Ulta Beauty's net sales experienced decent growth, rising by 6.4% from the prior-year quarter to nearly $2.5 billion. This growth was accompanied by a 4.5% increase in comparable sales, attributed to a 5.9% rise in transactions. However, this was slightly offset by a 1.4% decrease in the average ticket value. The company saw significant growth in the skincare, fragrance and bath product categories, while makeup sales remained steady and haircare experienced a slight decline. Despite the surge in revenue, operating income decreased, falling to $329.7 million from $362.7 million last year. This decline was primarily due to higher selling, general and administrative expenses.
Consistently high growth with superb return on capital
Ulta Beauty has demonstrated a remarkable growth trajectory since 2004, achieving high double-digit revenue increases in 17 of the past 18 years. The sole exception was in fiscal year 2020, when sales fell by 23.4% due to the adverse effects of Covid-19, including store closures, reduced operating hours and limited in-store services. From 2014 to 2023, Ulta Beauty expanded its revenue from $491 million to over $10.2 billion, achieving a compound annual growth rate of 18.4%. Equally notable is the company's consistent profitability and increasing operating income. Throughout these 18 years, Ulta Beauty maintained profitability each year. Its operating income soared from $18.5 million to $1.64 billion, marking an impressive annual growth rate of 28.3%.
The company's return on capital has been notably strong. Between 2004 and 2022, it consistently achieved double-digit returns on capital, with the exception of 2020, when it recorded a return of 8.9% due to the impact of Covid-19. However, the company made a robust recovery in the subsequent years, with the return on capital soaring to 37.8% in 2021 and further increasing to 41.8% in 2022.
Conservative balance sheet
Ulta has adopted a conservative capital structure despite the growing revenue and profitability. By the third quarter of 2023, it had $2 billion in shareholders' equity and $5.6 billion in assets. A significant portion of these assets comprises $2.32 billion in merchandise inventory, $1.12 billion in property and equipment and $1.58 billion in operating lease assets. The company maintains a low short-term debt level at $195.4 million. Its operating lease liabilities are relatively modest at $1.9 billion.
Upon examining the company's operating lease commitments, they are well-distributed over the coming years and are comfortably supported by its operating cash flow. In 2022, the operating cash flow reached $1.48 billion, while the average annual operating lease obligations stood at just about $325 million.
Source: Ulta Beauty's 10-K
Fairly priced now
So far this year, the company has bought back 1.8 million shares for $840 million and anticipates the total expenditure on share repurchases for the year to reach $950 million. Given the current share price of $470, this would equate to an additional purchase of approximately 234,000 shares. Consequently, by the end of the year, the company's total share count is expected to decrease by over 2 million, resulting in an estimated total of 49.7 million shares. Assuming the projected 2023 diluted earnings per share will be $25.40, this would correspond to net earnings of $1.26 billion. Factoring in similar levels of income taxes, interest expenses and depreciation and amortization to those of 2022, the company's Ebitda for the full year is projected to be around $1.9 billion.
Since 2004, Ulta Beauty's valuation has experienced significant fluctuations, ranging from a low of 4 times enterprise value/Ebitda to a high of 32.8 times. Over the past 18 years, the average valuation for the company has been approximately 15. Using this average multiple, Ulta Beauty's enterprise value is estimated to be around $28.5 billion, equivalent to around $540 per share. Discounting 15% for margin of safety, Ulta Beauty could be considered fairly priced.
The bottom line
I am seeing all the right signs pointing to a bright future for Ulta Beauty. Over the past 20 years, the company has shown remarkable strength, consistently increasing revenue and profits, delivering great returns and returning value to shareholders via share repurchases. It has the solid base in the beauty retail market, with a lot of room for potential growth. According to my analysis, the stock is currently fairly priced.
