Ulta's Earnings Disappoint Wall Street

Ulta Salon, Cosmetics, & Fragrance, Inc. (ULTA -2.08%) reported third-quarter earnings for fiscal 2013 after the market close on December 5. The results missed estimates on both the top and bottom lines, causing shares to tank over 18% on Friday, December 6th. The beauty retail industry has been performing well as of late, with Ulta competitors Regis Corp. (RGS 1.83%) and Louis Vuitton Moet Hennessy (LVMUY -0.11%) owned Sephora both registering strong growth in their respective businesses. Does this report auger worse days ahead for Ulta and the industry itself? Let's take a look at the report and decide if this is a buying opportunity or if we should steer clear of the stock for now.

The king of beauty
Ulta is the largest beauty retailer in the United States, providing a one-stop shop for all the beauty and salon products and services a consumer could desire. The company is dedicated to providing the highest-quality products at affordable prices, which is the recipe for success in any industry. Ulta currently operates over 650 locations in the United States, along with its very popular website, www.ulta.com.

Source: Ulta Salon, Cosmetics & Fragrance, Corporate Website

The results
After the close on Dec. 5, Ulta reported third-quarter results that disappointed analysts. Here's an overview of the report:

Earnings per share rose 18.6% and revenue increased 22.4% year-over-year, driven by same-store sales growing 6.8%. Gross profit rose an impressive 24.9% to $231.66 million, as the gross margin expanded 70 basis points to 37.4%. A quarterly record 55 new stores were opened during the quarter, bringing Ulta's total to 664 stores in 46 states. Although these statistics missed analyst estimates, I still believe they made for a very strong quarter. With this said, the biggest problem in the report was the guidance provided for the fourth quarter...

Outlook issues
The true issue analysts and investors had with Ulta's quarter was its guidance for the fourth quarter. Ulta now expects to earn $1.07-$1.10 per share when analysts expected $1.24. The company expects revenue in the range of $853 million-$867 million while analysts wanted to hear $895 million. The new expectations are much weaker than the company originally projected. Ulta stated that the decrease was a result of "softer retail sales trends at the end of the third quarter which are expected to continue." This is the weakest guidance I have ever seen out of Ulta, as it called for earnings growth of just 7%-10% from a year ago. Investors are used to 20% or higher growth consistently, so the after-hours decline of over 18% is warranted. 

The French powerhouse
Sephora is one of the largest fragrance and cosmetic companies in the world, making it a direct competitor to Ulta. The company deems itself as the market leader in France, Italy, and Russia, with a growing presence in North America, China, Latin America, and the Middle East. Sephora is owned by Louis Vuitton Moet Hennessy (LVMUY -0.11%) and currently operates 1,413 locations, with 29 being opened in the latest quarter.

In Louis Vuitton's earnings reports, it does not give results for Sephora specifically, but instead talks about it within the Selective Retail segment. In the first nine-months of 2013, revenue in Selective Retail rose 15.9% to 6.32 million Euros compared to 5.45 million Euros in the same period in 2012. The company added that Sephora has a growing market share in all key regions and is showing strong progress with online sales. At this time, it seems that Sephora and Ulta are growing in harmony, so I do not see the two as threats to each other. However, if Sephora sets its sight on rapid North American expansion, this story change. It should also be noted that the company has over 300 store-within-a-store locations within J.C. Penney stores as one way they are seeking growth in the United States. 

The hair cutting giant
Regis Corp. (RGS 1.83%) is the largest owner, operator, and franchisor of hair salons in North America and the United Kingdom, and is also a competitor to Ulta. It operates or owns interest in 9,752 salons under names such as Regis Salons, SuperCuts, MasterCuts, and SmartStyle. It also sells haircare and hairstyling products in its locations. On Nov. 5, Regis reported first-quarter results for fiscal 2014 that looked like this:

As you can see, the results were much better than expected and this has caused the stock to rise over 10.5% since then. However, the results were less than impressive on a year-over-year basis; earnings fell to $0.01 from $0.08 and revenue decreased 7.3%. Same-store sales fell 5.4%, as salon services decreased 3.1% and product sales decreased 14.8%. Although the market has reacted positively, I would stay far away from this one for at least one more quarter to see if the company can get back on track to year-over-year growth.

The Foolish bottom line
Ulta has been one of the best growth stories in the market over the last few years, so a stumble here and there should not cause investors to become bearish. In fact, I believe if the stock continues its decline over the next few trading days, investors should consider initiating a position. We do not want to try to catch a falling knife, but monitor this one closely and pick the level you believe would be too cheap to resist.