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The Science of Hitting
The Science of Hitting
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Ulta Beauty: A Difficult 2020 Continues

A look at the beauty retailer's results for the second quarter of fiscal 2020

September 21, 2020 | About:

Ulta Beauty (NASDAQ:ULTA) recently reported financial results for the second quarter of fiscal 2020.

As expected, it was another difficult quarter for the specialty retailer, with revenues declining by 26% to $1.2 billion and same store sales declining by a comparable amount (-27%) year over year, with a 36% drop in the number of transactions partially offset by a 15% increase in average ticket. As noted in the press release, the results improved meaningfully throughout the quarter: following a -37% comp in early May, the company excited the quarter with a comp of -10% in July, improving to a mid-single digit decline through the first three weeks of August.

The 26% decline in revenues in the quarter reflects significant growth in the e-commerce revenues, which more than tripled from the year ago period, offset by brick and mortar as Ulta began the process of reopening its stores in May. By mid-July, all locations had been reopened, with salon and brow services now available at nearly 90% of Ulta's locations, but not skin or makeup services.

At quarter end, Ulta had 1,264 stores, a 4% increase from the year ago period. After pausing its growth plans to preserve liquidity in anticipation of further uncertainty, management announced that they have resumed new store activity. For fiscal 2020, management expects to add a total of 10 net new stores, with early plans calling for roughly 30 new stores in fiscal 2021. To put those numbers in context, management had originally planned at the start of the year to add 75 stores in 2020. As shown below, the new guidance for 2020 and 2021 reflects a material slowdown in the pace of new unit growth for Ulta.

Gross profits in the quarter declined by 46% to $329 million, with gross margins contracting nearly 1,000 basis points to 27%. The primary contributors to lower margins was deleverage of fixed store costs, as well as channel mix shifts from in-store sales to e-commerce. The decline in selling, general and administrative costs exceeded the reduction in revenues on lower store payroll and benefits expense (the company furloughed 33,000 employees in mid-April), with adjusted operating margins contracting by roughly 800 basis points to 4.5% in the quarter. The company's repurchase activity was suspended throughout the second quarter; year to date, they've bought back $73 million of stock at an average price of $223 per share (diluted share count down 3% from a year ago).

At quarter end, Ulta held $1.4 billion in merchandise inventories, up 4% from a year ago. Given the fact that sales have declined by 30% year to date, there's clearly a meaningful mismatch between sales and inventories. The same is true for Ulta's competitors, which leads me to believe that the current environment could lead to intensified competitive pressures (as management noted on the first quarter call, "we are anticipating as a category potentially higher promotional activity"). This is something worth monitoring, particularly as we head into the holiday season.

Conclusion

Given the difficult results in the first half of fiscal 2020, with the company reporting an adjusted loss of roughly $24 million, the company clearly has work to do in the coming quarters. But despite the reported improvement in comp trends in July and August, CEO Mary Dillon believes it could still be some time before Ulta's results are back to normal:

"Given the continued disruption from the pandemic, new operational protocols, and near-term employment and economic uncertainty, we expect sales will continue to be challenged for the rest of the year."

As noted on the call, management is planning on comps to decline low double-digits to mid-teens in the back half of the year – suggesting a meaningful slow down from recent trends. Mr. Market does not appear to be too concerned by the company's lackluster results or Dillon's forecast: Ulta shares have been on an impressive run over the past six months (along with the broader equity markets) and currently trade at a price that's roughly 80% higher than the March lows.

While I remain intrigued by the story, particularly the fact that management seems willing to tweak their strategy given continued mix shift to e-commerce ("looking at our store footprint through an omni-channel lens to ensure we're strategically positioned to optimize share and profitability opportunities in every market"), I think shares are appropriately valued at current levels. For that reason, I will remain on the sidelines.

Disclosure: None

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The Science of Hitting
I desire to own high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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