Gadfly

Ulta Investors Are Just Confused

They mistakenly priced Ulta like a tech stock, but it's still a fine business.
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Photographer: Brian Ach/Getty Images

This summer's steep selloff in shares of Ulta Beauty Inc. shows that investors still don't understand the beauty-supply chain. 

It was just last month that Ulta closed at an all-time high of $313.73 a share, but it didn't stay up there for long. The stock tumbled 18 percent in the short time since then, erasing nearly all of its gains for the year. Investors could have avoided this roller-coaster ride.

Ulta may be one of the fastest-growing publicly traded retailers in America, but it's still a retailer. At its high, the stock was priced at 35 times estimated earnings for the future 12-month period, which is simply too rich a valuation in this highly competitive industry. Then all of the sudden, the dread of getting squashed by Amazon.com Inc. -- which has dragged down a swath of stocks lately with its Whole Foods Market Inc. takeover announcement and the success of Prime Day -- came over Ulta shareholders, too.

For now, that concern is mostly misplaced, which I'll explain later. But it at least had the effect of returning Ulta to a more reasonable valuation. That means shareholders shouldn't expect a big recovery until earnings start to catch up. The company still reaps less than 10 cents in net income on every dollar of sales. And as growth inevitably slows, profitability will become increasingly important to justify the stock price. 

Even though Ulta is a 27-year-old business, its popularity has skyrocketed in just the last few years and so investors are still trying to get a read on how sustainable its success will be. The chain has a footprint of nearly 1,000 locations, up from less than 200 a decade ago. 

But also, I'm probably not going too far out on a limb to say another reason investors misunderstand Ulta is that Wall Street is simply such a male-dominated community. If you're not a consumer of matte lipstick and BB creams, the space is difficult to get a handle on. The same could be said for women's fashion, but shoppers are even more particular about their beauty products than their clothing. Investors need to know that this is an advantage for Ulta, though -- customers tend to be stickier and are less fickle with makeup, skin care and hair products.

Will Amazon eventually break some of that loyalty? Yes, and Ulta will have to keep investing in its e-commerce business, but it isn't going away. Ulta already has a great website with the feel of being an Amazon of cosmetics (though the free shipping on purchases over $50 is probably hurting it some). Even so, for the next couple of years Ulta's toughest competition will continue to come from Sephora, department-store beauty counters and even drug-store chains such as CVS Health Corp. and Walgreens Boots Alliance Inc. Ulta is the only one that carries a full spectrum of brands, from the more affordable ones like Maybelline to higher-end names such as MAC and Becca. 

Ulta and Sephora have also both hooked shoppers with two things: product-testing before you buy and enticing rewards programs. Visiting their stores is an experience in a way that apparel retail just isn't, and that's a challenge for Amazon as it makes any push into cosmetics. Even the difficulty of being able to see the shades and hues well enough on a device screen can turn off a shopper. While larger items such as flat irons and perfume can usually be sent back to Amazon rather easily if the customer isn't satisfied, makeup and skin care isn't quite as simple. 

Ulta's growth prospects are still strong and investors need not be too concerned about the threat of Amazon yet. But they do need to maintain realistic expectations about what Ulta can accomplish because it is a retailer, after all, not some high-flying tech startup. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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