It's rare to see an unperforming growth stock these days, especially one that's been posting positive sales and earnings trends. But that's exactly the scenario investors face with Ulta Beauty (ULTA -0.40%), the spa and beauty products retailer.
Shares are down nearly 10% in the three months ended in mid-July, versus a 9% increase in the S&P 500. Year to date, the stock is up just 3% even as the wider market has surged 17%. Yet Ulta is expanding its business even after big gains a year ago. Profit margins remain strong, too.
Let's take a look at why Wall Street is wrong to be pessimistic about this stock right now.
Good growth
Ulta Beauty's late-May earnings report contained plenty of good news about the business, but most investors focused instead on the fact that average spending declined in the most recent quarter. This drop was due to slowing demand compared to a year ago. Management said competitors are increasingly using promotions to maintain sales trends, and Ulta Beauty followed their lead. "While we do not intend to lead promotional activity," CEO Dave Kimbell said in conference call, "we will respond as appropriate to protect and expand our share."
That response is working. Ulta Beauty posted an 11% customer traffic spike this past quarter. Comparable-store sales growth was 9% through late April, on top of an 18% increase a year ago. Those trends are not indicative of a company that's struggling on the market share or customer loyalty fronts.
Healthy margins
Ulta Beauty also remains highly profitable, although the short-term outlook is weak here. Price cuts helped push operating profit margin down to 17% of sales last quarter from 19% a year ago. Management reduced its 2023 outlook on this score as well, saying profit margin will land closer to 14.5% of sales as compared to the prior target of 15%.
ULTA Operating Margin (TTM) data by YCharts
That modest downgrade is no reason to abandon this growth stock, which is still on pace to pass $11 billion of annual sales in 2023. Before the pandemic, Ulta was booking around $7 billion of revenue and its operating margin was 13% of sales. It has improved both of these core metrics significantly, and investors have good reasons to expect further gains ahead.
The right price
Shares are looking more attractive lately after the recent stock-price pullback. You can buy Ulta Beauty stock for about 2.3 times annual sales, down from its peak of closer to 3 times sales. Sure, that's not a huge discount, and the valuation could always decline further if short-term demand trends worsen or if the makeup and skincare niches become even more promotional.
But Ulta Beauty is a strong growth stock that's winning market share in a large industry. Its profit margin remains high, and expansion opportunities are ample both in its stores and online. These factors should support excellent returns for patient investors over the next few years, especially now that the stock has become cheaper compared to the market in 2023.
