The stock price of cosmetics and personal care products retailer Ulta Beauty (ULTA 0.13%) roared ahead 24% last week after a stellar earnings report that showed the so-called "lipstick effect" is still at play.
Coined by Estée Lauder's Leonard Lauder, the Lipstick Effect theorizes why some companies, and beauty brands in particular, perform better than expected in times of trouble. The idea was first introduced during the market collapse precipitated by the dot-com bubble and 9/11, and hinged on the idea that consumers who were unable to buy truly upscale products would instead continue to purchase smaller indulgences.
Image source: Getty Images.
Ulta Beauty is an example of that popular indicator in action. First-quarter sales jumped 21% from last year to $2.3 billion, while net earnings surged 44% to $331 million, crushing Wall Street's estimates.
This shining performance helped bring the beauty care company's stock back into black for the year -- but only just barely. Let's take a closer look to see whether Ulta Beauty is truly back in vogue.
Overcoming the tide of low expectations
The first quarter results weren't a one-off for Ulta, as its fourth-quarter results showed a pick up in momentum, suggesting a return to normalcy. With the worst of the pandemic in the rearview mirror, consumers were out socializing once more; cosmetics and beauty care products were an important component of getting out among other people again.
Yet a single quarter doesn't make for a complete recovery, and with inflation running rampant, gas prices surging, and consumer pessimism in the air, many retailers have been stumbling -- and stumbling hard.
Analysts hadn't expected much from Ulta Beauty's first-quarter report and were lowering their price targets on the stock even as they kept "outperform" ratings on the business. As Deutsche Bank analyst Krisztina Katai noted ahead of Ulta's earnings release, the big misses she saw by retailers across the board crumpled their respective stocks afterwards, indicating the environment was "largely unfavorable" to Ulta.
Katai was not alone in her pessimism, as numerous firms downgraded Ulta's stock price, but as Katai noted after the report, Ulta "knocked it out of the park" with its first quarter results. In turn, Katai now forecasts future quarters where the beauty salon beats Wall Street estimates and raises guidance.
Image source: Ulta Beauty.
The network effect
This is more than a simple case of an analyst swaying whichever way the wind is blowing. There is a good reason to think Ulta Beauty is only just ramping up -- and that's where the Lipstick Effect comes in.
Ulta's business is strong and getting stronger. Growth is actually accelerating. Comparable-store sales were up an amazing 21.4% from last year, and though that was a low bar to step over, considering the impact of COVID was still in full swing, it was significantly better than the growth notched pre-pandemic when Ulta recorded 15.4% gains.
What's helped Ulta leverage that growth has been its member loyalty program, Ultamate Rewards, which ended the quarter with 37.7 million members, a 17% jump from last year. That program has been able to recapture older members who allowed their subscriptions to lapse during the pandemic and are now coming out to spend money at Ulta again.
Image source: Target.
Partnering for growth
Also helping to drive new growth is Ulta's partnership with Target (TGT 1.28%), which began last year and allowed for the installation of Ulta Beauty mini stores at 100 Target locations. The program has been so successful that the companies are adding over 250 more stores into the program this year, with an eventual goal of 800 locations.
In its most recent earnings call, Target noted that beauty has long been one of its fastest-growing retail categories, expanding 45% since 2019. With the Ulta partnership, that rate grew by low double-digits in the first quarter.
Ulta is using Target's strong customer traffic to expand sales and membership within its loyalty program, allowing members to earn points no matter which store they shop in.
Ulta also recently launched UB Media network, an advertising platform for cosmetics brands looking to tap into the tens of millions of loyalty program members. It likely won't move the revenue needle much by itself but could provide an incremental boost and enhance the synergies for its customers, making Ultamate Rewards an even stickier service.
Not the bargain stock it once was
The signs suggest that Ulta Beauty is swinging back from analysts' low expectations. The company is growing sales and revenue in addition to expanding how it reaches ideal customers. What's more, consumers have responded positively to the company's marketing, undeterred by broader macroeconomic headwinds, perhaps due to the so-called Lipstick Effect.
Although the retail stock is no longer as cheap as it once was, it's not wildly overvalued either. At 23 times trailing earnings, 19 times next year's estimates, and 20 times the free cash flow it produces, Ulta Beauty looks like a fairly valued stock, but one that still has room to grow. And that's not putting lipstick on a pig.
