The Industry Focus team concludes its discussion of Ulta Beauty (ULTA -0.20%) with a look at the company's tight margin structure -- from the cost of running physical stores -- and how that stacks up against profitability at fellow skincare and cosmetics leader Estée Lauder (EL 3.73%).
A full transcript follows the video.
This video was recorded on April 17, 2018.
Vincent Shen: If anything, I say to Joseph, and the thing that we've noticed looking at both of these companies in the past couple of weeks is that skincare and cosmetics are a really attractive sector and can be overall, with in this case, multiple great companies to choose from that might have different niches, different areas that they specialize in but overall, again, presenting growth numbers in the retail and consumer space that are just very, very impressive.
So I'll leave it to you, Asit. Any final thoughts or takeaways you would leave investors with, or Joseph specifically, based on either Ulta or both these companies or however it is?
Asit Sharma: Absolutely. A subtext of Joseph's question is, can these two companies thrive together, and I think you just touched on that, Vince. They actually are pretty complementary. Estée Lauder, for them, Ulta is a distribution channel. Many of the products which Ulta's management cites as faster growing products helping their sales happen to emanate from Estée Lauder. So it's good for both companies when the prestige brand and makeup at Estée Lauder do well. You can own both of these companies.
I would also say that the world has flipped a little bit, it's like a Shakespeare play right now in that at the end of a Shakespeare comedy, the jesters act as kings and sometimes the kings act as jesters. You mentioned this weird state that we're in with these two companies in that Estée Lauder has an earnings multiple which is trending right now around 35x forward earnings, and Ulta is down to 21x. So some of the skepticism is factored into Ulta, but it's not a bad entry point still. And for Joseph, maybe it's OK to hold the stock.
One last point I do want to make, though, respective to these margins, one layer deeper, why investors are a little bit skeptical. Vince talked about the fact that the company had a long-term growth target for operating margin of 15%, and they've dialed that back to 13%. Because of this massive, 20,000 product inventory the company carries, its gross margin is only about 35%. And out of that 35% of every sales dollar, it has to pay selling expenses, overhead. At the end of the year, it's close to profitability to Estée Lauder. Ulta has a net profit margin of 8.5% to 9.5% in a given year. We talked about last week how Estée Lauder has a 10% net margin. But if you remember from last week, Estée Lauder, because it doesn't have so many physical stores and has these multiple distribution channels, it has a gross margin of 80%. So it has a lot of space underneath that first line to play around with and experiment with. They spend a lot on R&D, etc. So they can react to adverse conditions, maybe, with a little bit more ease than Ulta can. So Ulta really has to manage its costs going forward and try to figure out what its ultimate -- again, bad pun there -- ultimate product mix will be to provide something close to that 15% operating margin that will get them their 10% at the end of the year.
But last thought, Joseph, it's not a sell here. This seems like a great company, still growing very, very strong, and is worthy of being in your portfolio. But why not buy them both? You can't lose. Estée Lauder, Ulta, good combination in the portfolio.
Shen: Thanks a lot, Asit! I'm really glad that you brought up some of the differences in the margin profile for those two companies, and the different levers that presents for management at each company. If conditions, as you mentioned, become adverse in one space, they can change things up with a little bit more flexibility there, probably, on the Estée Lauder side.