Ulta Beauty (ULTA -2.09%) investors have had good reasons to be cautious about the retailer's business lately. After all, its growth rate has slowed in each of the last five quarters, and profitability is on track to decline for the second straight year in 2018.
Yet the spa and beauty-products retailer remains an attractive business. To name just a few examples, it's winning market share in its core categories, amassing a large base of digital shoppers, and seeing quick positive returns on newly-opened stores.
CEO Mary Dillon and her executive team gave shareholders updates on these bright spots and the company's ongoing challenges in a recent conference call with investors. Below are a few highlights from that discussion.
Image source: Getty Images.
Winning market share
... [D]uring the second quarter, we benefited from strength in mass cosmetics, prestige skincare, fragrance, prestige boutique brands, and sun care. Each of these categories drove healthy double-digit comps with particular strength in fragrance and boutique brands. These gains were offset by continued softness across a few large brands of prestige cosmetics.
-- CEO Mary Dillon
Ulta Beauty's 6.5% comparable store sales gain last quarter represented its fifth consecutive quarter of deceleration since comp sales growth peaked at 17% in early 2017. However, executives estimate that the company still snapped up valuable market share in the period by nearly tripling the growth rate of the broader prestige beauty niche.
Management listed a few factors supporting that success, including the quality of the exclusive brands that Ulta has introduced to its stores and a marketing approach that's deepening the retailer's connection with its customers. Other bright spots included healthy growth in loyalty membership and rising demand for branded credit cards and gift cards.
Profitability challenges
Operating margin was 13% of sales and was down 100 basis points as expected from last year's Q2 results ... with 20 basis points of the decrease coming from the revenue recognition accounting change. Diluted EPS [earnings per share] increased 34.4% with the upside to our guidance primarily due to corporate overhead savings and timing of expenses.
-- CFO Scott Settersten
Ulta Beauty posted a slight decline in its gross profit margin and a more significant drop in its operating margin in the second quarter. But while profitability has been falling for more than a year, this decrease was driven mostly by temporary issues. The company booked elevated expenses related to the opening of a new distribution center in California and in-store upgrades to the spa section, for example. An accounting rule change also reduced its profit.
ULTA Operating Margin (TTM), data by YCharts.
Executives also pointed to "aggressive markdowns" as part of an inventory-clearing sale that pressured margins. However, the impact was minor and resulted in a far leaner inventory position heading into the key holiday selling season. That posture should allow plenty of room for new-product launches and sets up Ulta Beauty for healthier earnings in the back half of 2018.
New stores on the way
We continue to study new store productivity and observe cannibalization to be stable and well within our expectations so we feel very comfortable with our network strategy in reaching our target of 1,400 to 1,700 stores in the U.S. over the next several years.
-- Dillon
Executives affirmed their full-year outlook that calls for sales at existing locations to rise by about 7% this year. This forecast assumes that comp sales growth will accelerate for the first time in over a year during the third quarter. Ulta Beauty sees no reason to slow its physical store expansion, either. The retailer is on track to open 100 new locations this year, including entering Vermont, which would give it at least one store in every U.S. state. As of early August, Ulta operated 1,124 stores, but that could reach as many as 1,700 over time, management says.
Most of Ulta Beauty's 2018 new-store launches have already happened. That was a strategic decision by the leadership team, aimed at getting as many locations as possible up and running ahead of the major sales events around the holiday shopping months.
