Costco Wholesale (COST 1.01%) is an excellent business, but the stock has some big drawbacks. The warehouse giant isn't very profitable, even for a retailer, due to its price-leadership selling approach. And shares are expensive, potentially limiting an investor's returns from here.
If you're shopping around in this niche but would like another option, you're in luck. There's a large, growing national retailer that's been posting double-digit profit margins, along with market-thumping customer traffic gains in recent quarters.
Read on for some reasons to consider Ulta Beauty (ULTA -0.40%) shares right now.
Beautiful growth
The biggest knock against Ulta Beauty these days is that the business is going through a tough growth slowdown. Comparable-store sales were up 7% in the nine months that ran through late October, down from a 16% surge in the prior year period.
The makeup and beauty care niches are more price competitive lately due to this deceleration, giving Ulta and its peers less room to hike prices. That challenge combined with softer demand growth to make 2023 an unusually weak sales year.
Yet Ulta is faring well despite these issues. That 7% comps increase was powered by a robust 9% customer traffic spike that was offset by a nearly 2% drop in average spending per visit. Costco, in comparison, is boosting traffic by 4% in the core U.S. market, while average spending was down 1% last quarter.
Higher margins
Ulta is much more profitable than Costco. Sure, its operating profit margin has declined this year, slipping to 15% of sales from 17% of sales in 2022. This shift has contributed to roughly flat earnings, while most shareholders would prefer to see robust gains here.
But you'll still love the fact that Ulta's profit margin is far ahead of Costco's 3% rate. It's also well above the pre-pandemic profitability (of around 8% of sales) that investors were seeing as recently as 2019.
COST Operating Margin (TTM) data by YCharts
It's encouraging that this success arrived even as Ulta is facing more price-based competition and slower growth rates. Costco's management team makes it clear that the company intends to reinvest all excess cash into extending its price leadership, rather than allowing margins to rise.
Ulta, on the other hand, stands to see a rebound once the industry reaches a better balance between supply and demand. "The outlook for the beauty category is bright, and I am confident Ulta Beauty has the right plans in place," CEO Dave Kimbell told investors in late November.
The price check
Costco stock is near an all-time high and is also trading at close to its highest premium to date. That's not the case with Ulta, though. You can buy this retailer for 2.4 times sales, down from recent highs of closer to 3 times sales. Ulta is cheaper than Costco on a price-to-earnings basis, with shares trading at 21 times profit compared to Costco's elevated premium of 49.
It's true that a Costco investment delivers much more stability due to the chain's massive global sales base and the steady income that's powered by subscription fees. Yet Ulta's bright long-term growth outlook, combined with its impressive earnings power, should have investors feeling just as good about its opportunities to generate excellent returns over the next several years.
If you've found yourself waiting in vain for Costco shares to get cheaper, then maybe it's time to consider owning Ulta Beauty instead.
