Many growth stocks have soared in recent months as investors gained confidence that the U.S. economy will avoid a deep recession in the coming year. The Nasdaq Composite has jumped over 30% higher, helping lift the valuations of many individual stocks.
Yet, deals are still available in this quickly rising market. Consider Ulta Beauty (NASDAQ: ULTA), whose shares have declined 12% so far this year even though the retailer is growing sales at a double-digit clip and has recently boosted its revenue outlook for the year. While there are challenges ahead for the spa and beauty products specialist, investors have every reason to expect good things from this business.
Let’s look at why Ulta Beauty is a compelling buy opportunity today.
Looking at the first half of the year, there’s plenty of good news to highlight. Ulta’s sales are up 11% to $5.2 billion through the first two quarters of 2023. That boost came courtesy of a big spike in traffic at stores, plus a growing base of locations. Offsetting these gains somewhat was a slight drop in average spending. Shoppers are getting more cautious on makeup purchases, and Ulta and its competitors have responded by cutting prices in some cases.
But this approach isn’t harming profitability too much. Ulta’s gross margin is still stable at 40% of sales. It’s true that operating profit margin has declined slightly, which is unsurprising in an era of slowing growth.
Yet, Ulta executives recently affirmed that profitability will land at roughly 15% of sales in 2023 compared to the record 16% of sales that shareholders saw in 2022. Remember that Ulta’s pre-pandemic profit margin was closer to 12%, though, so the retailer is still on track to generate much higher annual earnings this year.
CEO Dave Kimbell and his team are targeting several attractive growth opportunities to support Ulta’s expanding revenue goals. There are new store launches to look forward to, for example, including through the retailer’s win-win partnership with Target. Ulta also has a popular loyalty program that’s already helping boost digital sales.
Wall Street has modest expectations for overall growth thanks to potentially sluggish consumer spending patterns. Ulta is likely to increase sales by nearly 10% this fiscal year, according to most analysts, and by about 5% in the next fiscal year. Those forecasts are significantly higher than the sales growth expectations for either Target or Walmart.
Investors have put Ulta’s shares in the bargain bin this year due to those lackluster growth expectations for the next few quarters. The stock is trading at just 17 times annual earnings, down from a P/E ratio of over 22 earlier this year. The same story holds true for Ulta’s price-to-sales valuation, which has declined to less than 2 from nearly 3.
Patient investors should consider taking advantage of that discount. Sure, Ulta may see some weaker results ahead, especially if rivals continue slashing prices in the face of slowing demand.
The retailer has already demonstrated that it can navigate that type of difficult selling environment without sacrificing its strong profit margins. Its leading market position means earnings will likely be impressive once the next cyclical upturn arrives. But in the meantime, Ulta is still on track to generate solid sales growth and profits in 2023 and beyond.
It should just be a matter of time before Wall Street notices the improvement and begins rewarding the stock with a richer valuation.
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Demitri Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Target, Ulta Beauty, and Walmart. The Motley Fool has a disclosure policy.
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