What happened
Shares of cosmetics retail chain Ulta Beauty (ULTA -2.73%) plunged 25.7% in May, according to data provided by S&P Global Market Intelligence. The analyst community grew more cautious about the company during the month, and its financial results fell short of expectations. Both factors contributed to the plunge.
So what
The largest piece of Ulta Beauty's decline came on May 25, when it reported results for its fiscal 2023 first quarter, which ended April 29. However, even before that event, the shares were already down more than 10% for the month. Contributing to the decline was commentary from Rupesh Parikh of Oppenheimer. According to The Fly, Parikh said he was more worried about Ulta Beauty's profitability than he was worried about its sales.
On May 19, Parikh lowered his price target for Ulta Beauty stock from $600 per share to $575 per share. Many investors look to Wall Street analysts for guidance, and Parikh's commentary and target price cut caused a minor sell-off of the stock.
However, the bigger drop came later when Ulta reported financial results that confirmed Parikh's fears.
In its fiscal Q1, Ulta Beauty had net sales of over $2.6 billion, a strong 12% year-over-year increase. However, the company's operating margin slipped from 18.7% in the prior-year period to 16.8%. This slip led management to lower its expectations for fiscal 2023. Previously, it had been guiding for a full-year operating margin in the 14.7% to 15% range. But now it expects an operating margin of between 14.5% and 14.8%.
Stock prices tend to follow profits over time. And with Ulta Beauty's profit margins slipping, the market bid down its shares.
Now what
I can't help but think the market is being short-sighted when it comes to Ulta Beauty and that May's sell-off is an opportunity.
Ulta Beauty operates in the cosmetics space, which tends to do well regardless of economic conditions. Furthermore, even with its reduced operating income expectations, a margin over 14% is quite good -- and higher than the company's 10-year average.
ULTA Operating Margin (TTM) data by YCharts.
Over the years, Ulta Beauty has been able to take advantage of the stability of the cosmetics economy and grow its sales per location, as well as open new locations. And it's also been using its strong profits to reward shareholders with share repurchases.
Because of this, its earnings per share (EPS) have tracked higher as its share count has consistently tracked lower.
ULTA Average Diluted Shares Outstanding (Quarterly) data by YCharts.
I expect the long-term trends to continue for Ulta Beauty: Sales will tick higher, the share count will trend lower, and EPS will keep rising, which should lead to higher stock prices over time. And given that it is now trading at just 17 times earnings, it has almost never been cheaper to initiate a long position in Ulta Beaty, which is something worth considering.
