Why Ulta Salon May Look Good

Why Ulta Salon May Look Good

Wall Street doesn't take bad news well. Ulta Salon, Cosmetics & Fragrance disappointed the Street recently and paid the price, as its shares fell more than 20%. While others shunned the stock, I was considering a purchase.

The beauty-products retailer has many appealing features, and its depressed market value looked intriguing when compared to unorthodox peers such as PetSmart and Conn's . But has Ulta's recent price drop made it an attractive buy? Let's take a look.

A sharp reaction to a disappointing forecast
Ulta Salon, a specialty retailer of prestige beauty products and salon-service provider, was a high flyer. Its shares had climbed more than 70% from a low earlier in the year, but that abruptly changed when disheartening future guidance irked the stock market and shares plummeted.

It seems the company's expectation for a 13% year-over-year increase in sales and comparable share earnings in the current quarter did not meet Street views. Management's admission of softer sales trends and possible pricing pressures only disappointed further.

While Ulta's forecast might have let investors down, its recent quarterly results were excellent. Sales increased 22.4% from 2012 with comparable-store sales improving 6.8%. Profits also did well. The gross margin jumped to 37.4% from 36.7%, the gross profit dollars grew 24.9% year over year, and net income increased 22.1%.

Ulta Salon has some attractive features
Ulta Salon has a lot going for it. One attraction is the potential for meaningful growth; after all, with only 664 stores increasing its footprint should not be difficult. The company added 55 new stores in the last quarter alone. Internet sales can also be enhanced--Ulta.com, the company's redesigned website, saw revenue pop 74.4% last period, but the site still only accounts for about 3% of total sales.

Besides potential operating gains, Ulta Salon offers a couple of less tangible enticements. A new CEO, Mary Dillon, was named in July. New CEOs have been known to ease pressure on future results by lowering expectations. While it can't be counted on, there is the possibility that Ulta might find it easier to match or beat analyst estimates in the future.

Another consideration is Julian Robertson. The famed investor, in an interview on CNBC, mentioned Ulta Salon very favorably. While investing on another's recommendation is not a great investment strategy, Mr. Robertson's view shouldn't be taken lightly.

Even with the positives, overpaying for the company might be a mistake. Based on expected current-year sales of around $2.7 billion and cash earnings (basically net income plus non-cash charges such as depreciation and amortization adjusted for expected capital expenditures) of $248 million, the company looks to be trading around 24 times cash earnings. Is this a fair price to pay for Ulta Salon? Some comparable companies may help determine the answer.

A couple of unconventional comparisons
Finding good comparisons for Ulta Salon is difficult. Stretching a bit, PetSmart and Conn's looked well suited. These choices may seem far fetched, but there is some logic to it. Ulta, at its core, basically sells products while also providing a related service.

PetSmart, the country's largest specialty pet retailer, generally does the same. Though pet supplies are obviously not the same as beauty products, some would argue taking care of one's pet often trumps taking care of one's self.

Another similarity is the company's admirable performance. PetSmart's latest quarterly earnings per share were up 17.3% year over year. Total sales rose 4%, and comparable-store sales grew 2.7%--all achieved, according to management, in a "challenged consumer environment."

Pet service revenue, which accounts for about 11% of total sales, increased a noticeable 5.2%. PetSmart has expanded its service menu astutely, and pet training, pet boarding, and doggie day camp are now all offered. Full-service veterinary care can also be found. Through a relationship with third-party operators, there are now more than 800 veterinary hospitals in company stores.

PetSmart shares look reasonably priced at around 15 times cash earnings, assuming expected sales of $7 billion and cash earnings of $510 million are achieved. The valuation seems fair as first-rate operating performance offsets its large size -- 54,000 associates and more than 1,314 stores -- which inhibits meaningful top-line growth.

Conn's, a specialty retailer of home appliances, furniture, and consumer electronics, offers products that may not be as personal as Ulta's but may be more essential. The company also offers an in-house financing service, uncommon in the industry. While most credit-worthy customers take advantage of financing via a Conn's-arranged third-party program, others get financing from the retailer itself.

While the influence of plentiful credit is hard to determine, Conn's has posted some astonishing numbers recently. In the latest quarter, total revenue increased 50.6% versus the prior year, earnings per share grew more than 80%, and the store gross margin jumped to 40.1%. A striking figure when you consider competitors like Best Buy and hhgregg have gross margins in the 24% and 29% area, respectively. The finance business also flourished, with revenue climbing 37.8% year over year as customer receivables grew to $945 million, a roughly 38% increase.

Based on expected revenue of around $1.2 billion and $102 million in cash profits, Conn's is trading at around 27 times earnings. This aggressive multiple may be acceptable given the company's recent performance, but investors should view the company's finance business cautiously; it can often be very volatile.

Final thoughts
Ulta Salon looks like an appealing stock. Its future appears bright and its valuation is much more attractive than a couple of months ago, but it still might be a bit too expensive at roughly 24 times cash earnings. Compared to PetSmart and Conn's valuation relative to performance, I'd prefer to wait for a slightly better price. If the shares do recede, however, investors might want to seriously consider Ulta Salon.

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The article Why Ulta Salon May Look Good originally appeared on Fool.com.

Bob Chandler has no position in any stocks mentioned. The Motley Fool recommends PetSmart and Ulta Salon, Cosmetics & Fragrance. The Motley Fool owns shares of Ulta Salon, Cosmetics & Fragrance. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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