We’d be shorting ULTA on the ‘strength’ (stock only up 3% AH). To be clear, there were very few holes to poke in ULTA this quarter, as the company put up $5.70 vs the Street at $4.99, driven by a 14.4% comp vs the Street at 10.5%. Guided up the year, but guidance implies a massive slowdown in 2H. Bulls tell us that the guidance is not real – that the company is ‘being conservative as usual’ and will come out and beat it materially. But we think that things are changing on the margin – both at the Macro/consumer level and with the competitive dynamics in the industry (and in retail in general, which will see severe discounting in 2H as other categories compete for Beauty dollars). No mention on the conference call of the 1,100 Sephora’s that are opening up on ULTA’s doorstep, which we found surprising as it poses an existential threat to ULTA’s business (see links to our Black Books below) – though management noted that gross margins are likely to be pressured in 2H as the promotional environment intensifies. That’s important, as the company is still putting up merchandise margins nearly 300bps above pre-pandemic levels – which we think will fully revert. Also keep in mind that the company is still running short by about 2,000 employees vs pre pandemic levels, and we think it will face both wage pressure and an increased employee count which will take margins lower.
So to sum it up, we’ve got sales decelerating and competitive pressures intensifying (Sephora/KSS, Amazon, cannibalization from the ill-advised move to put ULTA shops in Target, and Brands increasingly going direct to consumer) which should take gross margins lower, and we’re likely to see SG&A pressure on the labor front. All in, we build to about $20-$22 earnings annuity over the next three years – starting as soon as the 4th quarter. No way that’s worth 14x EBITDA.
If the company only ‘hits’ its guidance – which we think is more likely than not – then this stock gets cut by 30%. If we’re right and earnings top out at $22 in 2023, then this stock will get revalued on lower expectations and it could be cut by 50%. The upside/downside here is skewed to the downside by a factor of at least 3 to 1 – and that’s being conservative.
We have an incredibly hard time finding incremental buyers out there – as this name is a safe haven for long-onlies and HFs alike simply because the category is so strong. The stock is ridiculously undershorted at just 3% of the float short. Once the earnings algorithm rate of change becomes apparent, this stock is likely to revalue violently. We’ve seen this story play out before, and think that history is going to repeat itself. This stock sits at #2 on our Best Idea short list (behind GOOS), and if it hits $450 we’re likely to take it to the #1 slot.
We’ve done two Black Books on ULTA over the past three months outlining our full thesis on the name. They outline our thoughts in explicit detail. To see the presentation follow the links below.
June 29th Black Book – Full Thesis CLICK HERE
August 5th ‘2H Risk’ Black Book CLICK HERE
