Ulta Beauty Earnings: Nearly Blemish-Free Results Defy Tough Retail Environment; Shares Overvalued

Narrow-moat Ulta Beauty ULTA defied concerns around consumer spending to deliver top- and bottom-line outperformance in the second quarter. While second-half comparisons will be challenging and the economic outlook is murky, the firm raised its full-year guidance marginally. Specifically, it lifted its outlook for same-store sales growth to 4.5%-5.5% from 4%-5%, for operating margin to 14.6%-14.8% from 14.5%-14.8%, and for EPS to $25.10-$25.60 from $24.70-$25.40. We expect to raise our pre-report estimates of 5% same-store sales growth and $25.19 in EPS slightly given this outlook and Ulta’s second-quarter results, which should result in a mid-single-digit percentage lift to our $365 per share fair value estimate. However, we view Ulta’s shares as mildly overvalued as we believe its operating margins have peaked at about 14%-15% and anticipate its same-store sales growth will level off at about 4.5% in the long run.

Ulta eclipsed our 5% forecast with 8% same-store sales growth in the quarter. Its gross margin was 39.3%, down 110 basis points from last year and 70 basis points short of our estimate. There was some pressure on the gross margin from higher supply chain costs, theft, and discounting, but it remains well above prepandemic marks. Ulta’s operating margin was 15.5%, 10 basis points above our forecast. It cautioned that some expenses were shifted into the third quarter, but this was already incorporated into our forecast. Among other investments, Ulta is building its media network and technology, which we think supports its brand intangible asset. Quarterly EPS of $6.02 was $0.21 above our estimate.

We expect to adjust our Morningstar Uncertainty Rating on Ulta to Medium from High. This change is based on our quantitative model and improvements in the business over the past few years, such as its push into prestige beauty, its large e-commerce presence (nearly 20% of sales), its loyalty program of 42 million active members, and partnership with no-moat Target.