Hold on to This Winner, It's Still a Good Investment

Beauty retailer Ulta Salon, Cosmetics & Fragrance has gone from being ugly to pretty in the space of just six months. The stock was trading close to its 52-week low in March this year after Ulta's outlook disappointed analysts, but it hit a new 52-week high last Friday after second-quarter results beat estimates.

Shares spiked more than 16% after Ulta's earnings of $0.70 per share came in ahead of the $0.67 consensus estimate. The company's revenue of $601 million was comprehensively ahead of the $588 million expectation. What's more, the year-over-year readings were also fantastic. Revenue was up 25% from the year-ago quarter while net income jumped 28.3% to $44.9 million. 


Ulta's earnings guidance of $0.71-$0.74 per share for the current quarter -- below the expectation of $0.76 per share -- didn't dampen investors' spirits either. With the company reiterating its full-year guidance, there wasn't much reason to panic. 

But with shares trading at an expensive 42 times earnings now, should investors continue holding Ulta Salon? Given the company's impressive growth rate so far, and also the fact that analysts are expecting earnings to grow at an annual rate of 23% for the next five years, a rich valuation might be justified. 

Some pretty strategies
Ulta Salon has executed well on its strategies so far -- leading to tremendous growth -- and new CEO Mary Dillon is keen on building on the company's solid foundation further. Management will continue to focus on expanding the store network, merchandise additions, the e-commerce business, etc. 

Ulta Salon presently has 609 stores and it plans to open another 66 in the two remaining quarters of the fiscal year. More importantly, the company has been aggressively remodeling its existing stores and only 38 stores will run on the old format by the end of the year. In addition, new store productivity has also been robust as Ulta focuses on the quality of its locations along with marketing initiatives. 

Management has already approved 90 store sites for fiscal 2014 as it works toward its long-term goal of growing square footage at a rate of 15% to 20%. But to complement store growth, a strong product assortment is also necessary, and that's why the company keeps adding new products and services to its portfolio.  

Initiatives such as expanding its Benefit Brow Bars to 400 stores by the end of the year, making Ulta the biggest Benefit Brow provider in the U.S., and adding more Clinique and Lancôme boutiques look good. Ulta will be launching "several new brands" in the ongoing quarter. 

The expansion and robust performance of Clinique and Lancôme boutiques also suggests that Ulta Salon has been able to attract customers away from department stores such as Macy's . Macy's leads cosmetics sales in the U.S. with annual sales of around $3 billion, and its 840-plus stores eclipse Ulta's count. However, Macy's has been struggling of late as shoppers cut down discretionary purchases. The company missed profit estimates last month and also lowered its expectation for the fiscal year.

Ulta's interactive brand-building campaign is probably one of the reasons why it has been able to attract more customers from rivals. In addition, the company's loyalty program is doing well. Ulta now has 12 million members covered by its loyalty program, up 19% from the prior-year period. According to management, sales to these members have improved along with member retention rates. 

Ulta Salon saw an impressive 72% increase in its e-commerce revenue in the previous quarter. The company is looking to build on this success by adding more products and to keep interest levels intact, it is also redesigning its website. Considering these moves, Ulta's growth story looks set to continue as it seems to be in a good position to capture more market share in the beauty industry. 

Diversity counts
Ulta Salon's business model of selling beauty products, cosmetics, fragrances and providing salon services has proved to be a solid one and gives it a diversified look. This makes Ulta a better pick when compared to a cosmetics company such as Elizabeth Arden .

Arden is known for celebrity fragrances and Prevage anti-aging creams, but the company's results of late haven't been encouraging. Its dependence on department stores has hurt it as weak orders from its major retail customer in the previous quarter pushed it into the red. Arden had plunged almost 20% after its earnings guidance of $2.15 to $2.30 per share for fiscal 2014 came in way behind the $2.85 per share consensus.

The bottom line
So it's clear that Ulta's diversity is indeed an advantage, and the company has been making good moves to grow its business further. While it's true that shares are now trading at a rich trailing P/E multiple as stated above, robust earnings growth is expected going forward and that's why the forward P/E comes down substantially to 28x. Hence, investors should hold on to Ulta shares as the company can still deliver going forward.

The article Hold on to This Winner, It's Still a Good Investment originally appeared on Fool.com.

Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Ulta Salon, Cosmetics & Fragrance. The Motley Fool owns shares of Ulta Salon, Cosmetics & Fragrance. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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