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.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
- comps slow significantly
- investors start to worry that inventory build isn't totally benign
- investors stop fleeing from "at-risk" retail names