For several months, corporations across different industry sectors have attributed slowing revenue growth to lingering fears of recession. Investing during a recession can be particularly daunting as consumers seek to cut back on spending.
So-called "recession-proof" stocks are typically those of companies that sell consumer staples, such as food or cleaning supplies. On the contrary, companies that sell luxury purchases, like clothes or travel, may not perform as well during economic contractions.
Ulta Beauty (ULTA -0.40%), which sells cosmetics, seems to have defied this paradigm. Even during times of high inflation and recession fears, its business appears to do quite well. Let's dig into the fundamentals and see if Ulta can help give your portfolio a makeover.
What does the financial profile imply?
For its fiscal 2022 (ended Jan. 28), Ulta reported $10.2 billion in total revenue, up 18%, compared to 2021. In addition to increased revenue, Ulta's gross profit margin expanded year over year from 39% in fiscal 2021 to 40% in 2022. The company attributed the higher sales and margin to price increases and rising social trends such as the return-to-work environment.
On the expense side, operating expenses increased by 16% year over year. However, despite the increase in expenses, operating costs represented roughly 23.5% of total revenue in fiscal 2022, compared to 24% during fiscal 2021. Management explicitly stated that they made a conscious decision to pull back marketing expenses, in particular.
This isn't the first time investors have been told by corporate executives that marketing expenses are on the decline at a macro level. Big Tech has been talking about this trend for the last several quarters. This level of capital-allocation discipline should encourage Ulta investors.
The company's net income increased 26% annually to $1.2 billion, compared to $986 million during fiscal 2021. This surge in profits directly impacted the company's cash-flow profile. Ulta ended the year with $738 million of cash and cash equivalents on the balance sheet compared to $432 million at the end of January 2022.
Image source: Getty Images.
What are the underlying drivers?
Ulta has identified its core customers as "beauty enthusiasts." As per the company's investor presentation, a beauty enthusiast is one who engages with cosmetics beyond a daily routine. More specifically, Ulta is targeting people who use makeup and skin-care products as a form of creativity, wellness, and experimentation.
During the Q4 earnings call, CEO Dave Kimbell hit this point home when he said, "[O]ver the last two years, the U.S. beauty category experienced unprecedented growth, reflecting various factors such as product innovation, expanding regimens, new social media platforms, return to work and resumed social activities, and the elevated connection between beauty and overall self-care."
Investors shouldn't discount this point. The rise of social media applications, particularly short-form video platforms like TikTok and Instagram, has opened up an entirely new form of consumer engagement. It's not surprising that Ulta is expanding its reach beyond its 1,350 branded stores and 355 additional locations in Target locations.
Ulta is making a push into digital outlets to broaden its reach and enhance immersive user experiences. Kimbell spoke about this initiative in detail, stating:
Overall, unaided awareness grew significantly with meaningful gains among key audiences including Gen Z, Hispanic, and Black beauty consumers. Importantly, we increased the number of active members in our loyalty program by more than 3 million members, ending fiscal 2022 with a record-breaking 40.2 million Ultamate Reward members, who shopped more frequently and spent more with us, on average.
Ulta's management deserves a round of applause. The company is doing a stellar job identifying new ways to reach consumers and appeal to several different demographics. And it's been able to do so for now without going overboard on customer-acquisition costs.
What does valuation imply?
Valuation can be a tricky subject. For mature, profitable businesses like Ulta, looking at the price-to-earnings ratio (P/E) can be a decent methodology to determine if the stock is fairly valued.
Right now, Ulta's trailing P/E is nearly 22. By comparison, the long-term average of the S&P 500 is around 15 to 16. Investors can see that Ulta is valued much higher than the broader market. But one could argue that Ulta is a growth stock and therefore deserves its premium valuation.
Furthermore, Ulta stock is covered by several reputable Wall Street banks, including Raymond James, Canaccord Genuity, Piper Sandler, and Barclays. Each of these companies issued new research following Ulta's Q4 earnings report. These analysts believe Ulta stock could rise another 15% to 19% from current levels, and all have "buy" or "buy equivalent" ratings.
For current shareholders, now could be a great opportunity to lower your cost basis. Alternatively, new investors may want to accumulate a small position in Ulta as the company has proven that it can weather questionable, cloudy economic environments -- and still has ample room to grow.
