Killer quarter from ULTA. And yes, we’re short it. We got this quarter wrong. #accountability. But the stock is hardly budging on the print (admittedly after a 5-week rip into the numbers). But we think we’re nearing the end of the topping process on this stock, and would be pressing it at $475. The company blew away the consensus – putting up $5.34, a monster 35% growth rate vs last year, and 20% ahead of the consensus. But we think these huge beats ULTA has been putting up in recent quarters are coming to an end. The company noted that November moderated, it saw Mass outperform Prestige – suggesting that the consumer is trading down, and again suggested (again) that holiday will be promotional – which is consistent with the uptick we’re seen in recent weeks in beauty promotions and the slowdown in traffic. The company goes up against much tougher compares in a much more questionable environment starting in 4Q, and then in 2023 we see the impact of 1,150 Sephora stores being open inside Kohl’s right on ULTA’s front doorstep. Tops are processes – not points – and we think that the topping process here is nearing an end.
In fact, though the company did not give guidance explicitly for 2023, it noted that sales growth is likely to mean revert in 2023 to a comp rate of 3-5%. Yes, it probably thinks it can do better. But we think that this is closer to the truth than not. 2022 has been an extremely strong reopening year for beauty, and on top of that the company has had some phenomenal growth with new brands like MAC, Channel and others that drove mix higher. Let's also not forget price increases. It also gained share from Kohl’s (among others) that have beauty departments closed down while it builds out Sephora shops. Then comes the margin equation. Remember that 500bp of the comp – or a third of sales growth in the quarter – was driven by price, which flows right through to margin at a 100% rate, something we think will be near impossible to hold next year when it faces a major existential threat in Sephora (which is owned by LVMH) – not to mention the severe price reversion we expect to see across nondurable and durable goods alike in the early part of 2023. This company is over-earning on Gross Margin by about 400bp, and we think it values its comp more than it does maintaining its gross margin. In other words, it is likely to compete it away. Then there’s SG&A where the company is getting hit with major wage inflation (just like the rest of retail) and is pulling back on marketing to soften the SG&A blow. The company is sticking with its 13-14% margin targets, and it’s currently operating at an annualized rate of 16%. In the Q&A, analysts were trying to get management to ‘fess up’ that margins are at a new permanently higher level. Management wouldn't budge. It's clinging to reality, which is a low teens margin -- something we think is correct, but the market is unwilling to believe until they see it. But like other parts of retail, we think that beauty – especially in light of an increased competitive dynamic – will mean-revert not just to 2019 levels, but recessionary levels. This model SCREAMS slowdown.
So put it all together, and we think that in 2023 we’ve got mid-single digit topline growth, flat gross profit growth, and down EBIT, with the only EPS growth coming from the company’s stock repo activity in 2022. To be clear, we don’t think it should be repo’ing its stock here. Yes, business is great and its got the cash, but that doesn’t mean it should be buying back the stock at all time highs when we’re looking down the barrel of a dramatic negative sequential change in the P&L and likely downward revaluation in the stock.
So the big question is what is ULTA worth? It’s currently trading at 14x EBITDA, and on such a dramatically slowing growth algorithm for an over-stored retailer (or at least one that’s in the ninth inning of unit growth) it probably deserves something closer to a 10x multiple on down EBITDA. Is this a quality company? Of course it is. But we think that 2023 will go down as the year where ULTA goes from ‘great’ to ‘good’, which is a multiple deflator any way you cut it. Though the stock ripped by 24% over the past 5 weeks – in part with the retail rally and in part bc we saw so much short covering ahead of this print – it’s flattish on a blow out number. That speaks volumes. 10x on our 2023 and TAIL EBITDA estimate gets us to a stock of about $275-$300, or ~40% downside in what is arguably the biggest safety stock in consumer discretionary outsize of Amazon. We’d be shorting aggressively at current levels, and will be following up with a Black Book on ULTA and our take on trends in the beauty space in early 1Q.
