Description

Ulta is a perfectly good company, but it has a combination of factors that make it a very attractive short at current levels.  I believe the current valuation is related to consumer-focused investors fleeing to perceived "safe" stocks that will not be immediately destroyed by the online threat.

1) Unsustainable comps.  Ulta has had a good run of comp drivers over the last 6 years, namely:

- rebound from a deep 2008-9 decline helped 2010-12

- high percentage of immature stores with steep maturation curves (2011-14) 

- redesigned online presence and marketing focus (2013)

- redesigned loyalty program (2014)

- new brand additions (2014)

- declining department store traffic (2015)

the last will almost certainly persist, but the rest are mostly played out at this point.  much like chipotle, when a concept comps low-mid teens and investors don't really understand why, it is very easy for the comps to come back to MSD.

2) More competition.  While Ulta seems to have a better mousetrap than drug stores and department stores for now, no one is sitting still.  Specifically:

- drug stores are redesigning/expanding cosmetics sections

- online competition is rising (including Amazon)

- Ulta lookalikes are spreading (beauty brands, sephora, blue mercury, e.l.f)

- brands are going direct

3) Valuation.  Even if Ulta builds out an entire national footprint, it is fairly valued:

- 1,700 stores

- $6m/store (vs. current $5m/store, despite smaller stores and cannibalization)

- 18% ebit margin (basically among the best margins of global retailers)

- 18x multiple (market multiple despite fully mature business)

Gives $315, equal to the current price.

Catalyst

- comps slow significantly

- investors start to worry that inventory build isn't totally benign

- investors stop fleeing from "at-risk" retail names