Ulta Beauty Inc.'s (ULTA, Financial) growth days are over and its shares are no longer attractive, according to Quo Vadis President John Zolidis.
On Thursday, the beauty retailer reported lower fourth-quarter earnings due to lower sales and disappointing guidance. Fiscal 2021 margins will be much lower than the Street thought, as long-time and highly respected CEO Mary Dillon is heading for the exit.
Ulta Beauty has experienced strong revenue and earnings growth over the last three years, beating Target Corp. (TGT, Financial) by a significant margin, as shown in the table below:
| Company | Ulta Beauty | Target |
| Three-year Revenue Growth (%) | 18.1 | 11.9 |
| Three-year EBITDA Growth (%) | 14.4 | 13.2 |
| Current Operating Margin (%) | 6.14 | 6.99 |
| Current Price | $345.77 | $176.87 |
| GF Value | $260.28 | $122.25 |
The problem is that its economic profit, a measure of value creation, has declined from 23% in 2018 to -3.94% this year, meaning that the company is destroying value as it grows at this point.
Meanwhile, the economic profit of Target, its competitor and recent partner, has been rising, reaching 9.42% in 2020.
| Company | ROIC | WACC | ROIC-WACC |
| Ulta Beauty | 7.93% | 11.87% | -3.94% |
| Target | 16.56% | 7.14% | 9.42% |
Zolidis attributes Ulta Beaty's problems to several factors, like a recession in the makeup category, which caused a decline in the company's sales before the Covid-19 pandemic. "PROBABLY THE BIGGEST NEGATIVE FUNDAMENTAL METRIC OUT OF 4QFY20 WAS NO SEQUENTIAL IMPROVEMENT IN MAKEUP (still down 19% YOY)," he wrote. "It's no surprise that the company says it has little visibility on a turn, and Ms. Dillon senses the same thing."
Then there's the change in the competitive landscape brought about by the pandemic. Prior to the coronavirus outbreak, Ulta Beauty could grow by gaining market share from traditional retailers. But that opportunity ended as shopping shifted online during the pandemic, a space crowded with big players like Amazon (AMZN, Financial), the company's vendors and mass retailers that can bundle orders.
Meanwhile, there's a slowdown in unit sales. Unit growth in 2020 was around 1%, far below the 8% level in 2018.
"Going forward, we think shareholders will be lucky if annual growth rises to 3%," Zolidis said.
In short, Ulta Beauty is no longer the high-growth company it once was, and its shares deserve a lower valuation.
How much lower? Applying a price-earnings ratio of 20 on earnings of $11 per share, Zolidis thinks the stock should be trading at $220, well below the $350 it was at on Thursday.
He has a sell rating on the stock.
Disclosure: I own shares of Target.
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