Narrow-Moat Ulta Beauty Continues to Shine, but Comparisons Will Get Tougher; Shares Expensive

Wrapping up an exceptional year, narrow-moat Ulta Beauty ULTA lapped our expectations in 2022′s fourth quarter, posting 15.6% same-store sales growth against our 7.5% forecast. While approximately 500 basis points of the increase was attributable to price increases, traffic remained very strong (transactions were up 13.6%). Although there has been much concern over slower consumer spending amid high inflation, beauty, powered by a rising interest in wellness and product innovation, has been very resilient. Given the outperformance, we expect to lift our $352 fair value estimate by a mid-single-digit percentage, but view Ulta’s shares as overvalued.

Ulta’s 37.6% gross margin in the fourth quarter matched last year’s result and eclipsed our estimate by 10 basis points. The firm typically posted fourth-quarter gross margins in the 34%-35% range prior to the pandemic, so the result affirms our view that its gross margins are structurally higher now attributable to its product, pricing, and customer engagement efforts. Moreover, due to the sales outperformance, its 13.9% operating margin beat our forecast by 170 basis points. While its own expansion and pressure on wages and other costs have pushed Ulta’s selling, general, and administrative expenses higher, they remain in the range of 23%-24% of sales that we model.

Ulta’s outlook for 2023, including same-store sales growth of 4%-5% (down from a stellar 15.6% in 2022) and an operating margin of 14.7%-15% (16.1% in 2022), reflects some slowing in its momentum, and aligns with our forecast. Our long-term estimates assume Ulta holds operating margins around 14%-15% while achieving annual sales growth of roughly 6%-7% from store openings and 4%-5% comparable sales increases.