Ulta Beauty's (ULTA 0.98%) third-quarter operating results included two nasty trends that investors never like to see in a retailing business: Sales growth slowed sequentially and profitability declined. Together, these shifts usually imply a difficult selling period ahead. And, in fact, Ulta's management team forecast another year-over-year growth slowdown for the fiscal fourth quarter.
Yet CEO Mary Dillon and her executive team projected confidence that the beauty and salon services retailer is still on the right track. In a press release, they said Ulta's merchandising and marketing initiatives "allowed us to drive significant share gains, continue to rapidly grow our base of loyalty members, and thrive amid shifting category trends within the beauty industry."
Dillion added context to that statement in a subsequent conference call with Wall Street analysts. Here are the highlights from that discussion.
Market share wins
Ulta Beauty continued to rapidly grow our share of prestige makeup, accelerated our gains in prestige skincare and fragrance, and added 320 basis points of market share in prestige beauty overall.
Sales growth dipped to (a still strong) 10% from 12% in the prior quarter and gross profit margin slipped by more than a full percentage point to 36.7% of sales. Management said two main factors drove those worsening trends. First, hurricane disruption in the key markets of Florida and Texas reduced comps by about 1 percentage point. Second, and more worryingly, demand weakened in the makeup segment, which forced the company to reduce prices to keep inventory moving.
Executives were happy with the results of those promotions, though, as they kept customer traffic growth elevated and drove increased market share, especially in high-margin product categories.
We were able to open almost all of our 100 net new stores in our 2017 program before Black Friday weekend to take advantage of holiday traffic and sales.
Ulta ended the third quarter with 1,058 stores and by late November the company has essentially hit management's goal of adding 100 new stores to the sales base during the year. That means the business will benefit from all the extra retailing square footage during the critical holiday shopping period. This new crop of locations is meeting the high bar that executives set for budgeting and profitability, and so there has been no change in Ulta's expansion strategy. Dillon and her team plan to add another 100 stores to the portfolio in 2018 to take another big step toward the roughly 1,700 locations they believe the U.S. market will support.
For the fourth quarter, we expect sales to be in the range of $1.926 billion to $1.959 billion versus $1.581 billion last year. We expect comparable sales to increase in the range of 8% to 10% versus 16.6% last year.
-- Chief Financial Officer Scot Settersten
Despite the slowdown expected in the fourth quarter, Ulta affirmed its full-year sales growth guidance that calls for comps gains of between 10% and 11%. There's just a minor impact baked in from the increased promotions, too. Operating margin is now expected to be flat in 2017 rather than rising slightly as management had initially predicted.
The long-term goals aren't changing, though, and Ulta still believes it can grow earnings by at least 20% per year as operating margin climbs up to 15% by the end of 2019 (from 13% in 2016). More industry challenges are bound to occur in the meantime, but the retailer's strong market position and growing sales base, both in stores and online, should help it navigate through them without sacrificing much in the way of profitability.