Update On Ulta Beauty ($ULTA)
And The Importance Of Not Following Famous Investors Blindly
One month ago I wrote a (long) deep-dive about Ulta Beauty (ULTA) called “ULTA: Waiting for Strategic Clarification” and unfortunately the wait will have to be prolonged. In that article I detailed the reasons why I preferred to stay in the sidelines and wait for additional clarification about their growth plans, that would probably be provided in the next earnings call (or the next Investor Day planned for October).
Since that publication there have been two events in relation to ULTA worth commenting on:
Berkshire Hathaway (Warren Buffett’s holding company) disclosed on August 14 a position in ULTA with the filling of its last Form 13F (~1.5% of ULTA).
The Company published its second quarter results on August 29 (yesterday after the close).
With regard to the second quarter results, the clarifications provided by the Company are far from being enough and the uncertainties mentioned in my previous deep-dive are alive and kicking:
Growth keeps gradually declining.
Net sales in the quarter slightly increased (+0.9%) mainly thanks to new store openings (+49 stores in the last 12 months) but comparable sales declined 1.2%. In the meantime Sephora reported double‑digit growth for the first half of the year (vs. +2.2% in ULTA).
Two of its most relevant categories, makeup and hair, decreased mid-single and high-single digits, respectively, in terms of comp sales (partially offset by double-digit growth in fragrance and mid-single digit comp growth in skincare).
The Company admits that “it will take time to shift the top line trend” (for the reasons we will see in the next paragraphs).
Besides the Company is reaccelerating its store openings, which can be positive for the future, but could impact margins through deleverage of store fixed costs in this sluggish growing environment.
Competition is increasing.
ULTA recognizes that “competitive intensity in the beauty category remains high” and blames this unprecedented environment “with more than 1,000 new points of distribution opened in the last three years” where “more than 80% of (their) stores have been impacted by one or more competitive opening in recent years, with more than half impacted by multiple competitive openings”. They think that this should be a short-term impact (“we have historically seen a short-term impact on new distribution points on our existing store when a competitor opens near one of our stores”) but they admit competitive pressures will continue at least for some time.
Besides ULTA keeps losing market share in prestige beauty (while again Sephora reports “record‑breaking market share thanks to the expansion of its store network and the successful partnership with Kohl’s” and Amazon seems to keep gaining market share too).
Premiumization.
Premiumization, the trend where consumers are willing to trade up and spend more on high-quality products, is far from slowing down and, as explained in the previous deep-dive, there are other retailers (e.g. Sephora or Bluemercury) that are better positioned to take advantage of it.
This is perfectly reflected in this quarter, where ULTA has been able to maintain its market share in mass beauty, but have lost share in prestige.
Macroeconomic pressures.
ULTA comments that “the operating environment remains dynamic” and that the “consumer behavior is starting to shift as consumers increasingly focus on value and become more cautious with their spending”.
Within this environment, the Company has been forced to increase its promotional activity, but it hasn’t been able to reactivate purchases (at least in-store purchases) while at the same time is negatively impacting its merchandise and gross margins.
The Company mentions in the last earnings call the many actions that are taking to reverse the current situation: strengthening its assortment; increasing social relevance and brand awareness; enhancing digital experience; leveraging its powerful loyalty program; and evolving promotional strategies. However, again, all these initiatives are in early stages and till now there are no specific evidences that they will be able to turn around the current situation. Besides there is no mention (or superficial comments) to many relevant aspects to ULTA’s future: the international expansion (specifically Mexican expansion scheduled for 2025); the number of stores to be open in the near future; if and why Ulta Beauty at Target store openings seem to be slowing; if and why the incorporation of new Ulta Beauty Rewards members seems to be also slowing down; or how the expansion into outlets is performing and what to think about the future in this area. In that sense, I prefer once again to wait for additional clarification about their growth plans and gather more data to see if the growth story remains intact, which, according to the Company, are expected to be provided in the next Investor Day in October.
With regard to Berkshire Hathaway’s stake, Warren Buffett’s investment conglomerate unveiled a position of 690,106 ULTA shares as of June 30 (worth ~$266 million at that time). The market reaction was very positive, as expected, with the stock skyrocketing more than 10%. However this is a reminder that within the stock market makes little sense to follow blindly other investors’ bets and indeed is a very dangerous practice. This does not mean that Warren Buffett’s investment in ULTA was wrong. He is one of the most famous investors (and probably the best one) and he (or his partners) has for sure good reasons to be invested in ULTA. The problem is that they know the reasons behind their investment and they can now make (or keep) decisions based on the current earnings report. People that follow blindly famous investors are also blind for the rest of the investment process (the “hold” part) and will make mistakes as new information arrives because they will not be able to understand what is really happening or if the thesis remains intact or have changed.
I still believe that ULTA is a great company and that its historic and impressive evolution invites to be optimistic. However in my opinion it is time to remain on the sidelines a little bit longer.