Technically speaking, a bottom in stock prices isn’t a bottom until it's been confirmed by a second bounce, and Ulta (NASDAQ: ULTA) is a prime example. The first entry signal is typically the strongest and provides the biggest gains but also comes with the most risk. A stock in a downtrend can continue to move lower despite experiencing periodic relief rallies. That’s why waiting for the second signal is the smartest move.
Ironically, the second signal, which is often weaker-looking regarding the price action, is called the Strong Signal because other indications, including oscillator or moving average signals and breaks of resistance, compound it. Ulta, which fired a strong-looking signal earlier this year, has retreated to the critical support target. The question is whether it’s time to buy or prepare for a much bigger sell-off in this retail stock.
Ulta Beauty Misses Mark as Headwinds Cut Into Results
Ulta Beauty had a weak quarter relative to expectations, but the news isn’t as bad as the implied 10% pre-market drop in share prices. While revenue and margin were weaker than expected, results remain solid, and the long-term outlook is robust. The $2.68 billion in net revenue missed by only 37 basis points, a slim margin, and cash flow is sufficient to sustain the fortress-quality balance sheet and value-generating capital return.
Margin is the weak spot in the report, contracting more than expected. Gross margin contracted by 100 bps and operating margin by 260 to drive a 12% decrease in GAAP earnings. As bad as it sounds, the weakness is caused by factors that will either evaporate in the current quarter or can be directly addressed by management, including a consumer shift towards value, operational turbulence related to the ERP shift, and a weaker-than-expected impact from promotions. Regarding the ERP shift, once completed, it will help generate efficiencies, drive traffic, and aid in improved implementation of promotions.
The bad news is that Q2 results, industry normalization following years of stimulus-induced consumer habits, and increasing competition cut into the guidance. The company significantly lowered the guidance for full-year results, shaving 1000 basis points off the GAAP EPS forecast. The risk for investors is that guidance remains optimistic; the opportunity is that Ulta Beauty execs will refocus their efforts, outperform the guidance, and lead to an analyst upgrade cycle.
Headwinds Are No Deterrent for Ulta Beauty’s Capital Return
Ulta Beauty doesn’t pay dividends; it buys back shares in bulk, reducing the count by nearly 4.4% diluted over the last year. The repurchases are expected to continue because of the $2 billion remaining under the current authorization and the solid cash flow.
As expected, cash flow was negative for the quarter but positive YTD, and compared to last year, the cash position increased while receivables and inventory rose. The rise in inventory is due to new product launches and store openings, 14 net for the quarter, aiding the 11% increase in current and 9% increase in total assets. Leverage remains ultra-low with total liability running at 1.44x equity and 1.2x assets and long-term liability ex-lease obligations at 0.14x cash.
The analysts' response to the news is negative, including numerous price target reductions and at least one downgrade within the first 12 hours after the report. The activity will weigh on the market and suggest a new low will be set, but ultimately, it will support the market; this market can only fall so far.
The reason a new low could be hit is that a new low price target of $300 was set, $20 below the previous low and the critical support target. The activity is supportive for the market because it is still rated a Moderate Buy, the downgrade from Raymond James is to Outperform from Strong Buy (essentially no difference), and most fresh targets suggest a rebound to the $400 level is likely. The takeaway is that Ulta Beauty's stock price faces headwinds but is a buy-on-the-dip opportunity for patient investors.
