Is Ulta Beauty Stock Suffering From Success Fatigue?

The Industry Focus crew recently debuted coverage of Estée Lauder (EL -0.67%), and an Ulta Beauty (ULTA -1.59%) shareholder wants to know:

We hold Ulta and have watched its stock go on sale over these months, unfortunately. It was interesting that Estée Lauder hadn't listed them as a competitor. I guess these companies thrive together, then. Both are staking their growth on premium products like MAC, for example. I hadn't anticipated anything like the decline in Ulta, and I'm further surprised at its contrast with Estée Lauder. Can you square the market's perspective here?

In this video, the cast dives into the factors that have caused Ulta stock to decline 20% in the past year, even as Estée Lauder shares soar to new all-time highs.

A full transcript follows the video.

This video was recorded on April 17, 2018.

Vincent Shen: Moving on, now, to the heart of Joseph's question -- why the big discrepancy to how Ulta's stock has performed in the past year compared to Estée Lauder. If you had to boil it down, Asit, what's your take here on the differences?

Asit Sharma: One of the primary differences, Vince, is success fatigue, in my eyes. If you take a look at this company since the IPO -- Ulta IPO' d on Oct. 25, 2007. I ran a quick chart of this before the show. Just fast forward a little bit over the last 10 years -- this not quite 10 years, it's actually about 11 years since the IPO. Over the last 10-year period, this stock has returned 1,500%, which puts it in really rarefied air, with some of the names that we talk about, not you and I personally as much on this show but some of our colleagues who regularly cover stocks like Netflix and Amazon. That's tremendous growth.

Now, if you actually go to the IPO date and take that chart all the way to this morning, this stock has returned about 684%, and that includes that downdraft that you mentioned, Vince. Now, run Estée Lauder beside this company from the IPO date to today on a total return basis, Estée Lauder, which we talked about last week, has returned 685%. They returned 1% more on a total return basis since Ulta IPO'd. And that's a function, again, of Ulta slowing down and this stock coming back.

And what happened is basically, last year, for the first time in this string of quarters, the company missed its first earnings estimates. I'm not a huge fan of investors overreacting to one or two quarters, but often times, you see people who have been in a stock for a long time -- I'm saying people here, but I'm also referring to institutional investors, corporations, pension funds, etc. -- once they see that the growth story that has propelled the stock something like 1,500% may not be as intact anymore, they tend to start pulling out. And with those outflows, a stock will reset a bit.

And I think really, that's all that's happening here. Looking at their top line, they grew revenue 21% last year. That included that fast store opening piece that you mentioned, plus comparable sales growth of 11%. So Ulta itself hasn't slowed down so much as it's not potentially going to grow that fast clip, or as fast a growth rate as it has in the past. And some investors want to take profits off the table. I'm going to flip it back to you, Vince. One thing I'm also interested in talking about is competition and how some of those concerns might affect the stock trajectory. But what do you see in terms of why Ulta may have slowed down a bit?

Shen: Sure. I agree with a lot of the points that you made in terms of investors, especially those who have been on this upward roller coaster for a long time, wanting to take some profits, having to reevaluate the prospects and the long-term trajectory for this company, given that some of the growth rates are moderating, their guidance for next year is a little bit lower. I'm sure some investors are disappointed about that, but again, for Ulta, there's a reason why we chose it last year as one of these best-in-class brick-and-mortar retailers, because they are still putting up extremely enviable comparable-sales growth and other numbers.

But the things that jumped out to me were, on the growth end, some of the things we've talked about in terms of that moderation but also with product mix. If you listen to the leadership at Estée Lauder, they talk about how their focus on prestige brands is really helping them to enjoy some of the strongest growth in the space, and that is the company's primary focus. And Ulta, on the flip side, has risen to prominence by being a one-stop shop for all these different products -- fragrance, skincare, cosmetics, salon services -- but also across a lot of different price points.

And you would think that the mass market is where Ulta felt the most pain, but that's not necessarily the case. It's interesting, because the company called out specifically prestige skincare, prestige fragrance, and mass-market cosmetics in the last earnings call as really strong categories with double-digit comparable sales growth. Then, meanwhile, prestige makeup actually saw its comps growth cut in half during the fiscal fourth quarter. So there's a lot of granularity here, because prestige makeup is seeing greater competition, weaker demand. However, the makeup segment overall is over half of total sales for Ulta, and it's a smaller portion at about 40% for Estée Lauder. So I think that explains some of the difference in the tone being expressed by the two companies and their management teams in terms of how those things shake out, and how that's affecting their guidance and their growth prospects going forward.

And something else to keep in mind, too, Estée Lauder at this point is trading at all-time highs. They're not that far off from having double the price to earnings multiple of Ulta. So are these two companies, if you look at them, growing at such different rates with their near and mid-term guidance that would justify such a big difference in their valuations? I would say no. I think that Ulta, also being in a more traditional retail-focused business, a lot of investors these days will see it as more of a weakness, given the retail environment that we've seen in 2016 and 2017, maybe punish the company a little bit more that way, whereas Estée Lauder, as we mentioned last week, touts the diversity of their channels and all these different partners and customers that they can sell through and how that's a strength for the company, we would agree with that.

So I think that gets to a little bit of the core of some of the differences that we've seen in the prospects for the stocks and how investors are interpreting those different results.