What Ulta Beauty Wants Investors to Know

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Ulta Beauty (NASDAQ: ULTA) investors have had good reasons to be cautious about the retailer's business lately. After all, its growth rate has slowed in each of the last five quarters, and profitability is on track to decline for the second straight year in 2018.

Yet the spa and beauty-products retailer remains an attractive business. To name just a few examples, it's winning market share in its core categories, amassing a large base of digital shoppers, and seeing quick positive returns on newly-opened stores.

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CEO Mary Dillon and her executive team gave shareholders updates on these bright spots and the company's ongoing challenges in a recent conference call with investors. Below are a few highlights from that discussion.

Winning market share

Ulta Beauty's 6.5% comparable store sales gain last quarter represented its fifth consecutive quarter of deceleration since comp sales growth peaked at 17% in early 2017. However, executives estimate that the company still snapped up valuable market share in the period by nearly tripling the growth rate of the broader prestige beauty niche.

Management listed a few factors supporting that success, including the quality of the exclusive brands that Ulta has introduced to its stores and a marketing approach that's deepening the retailer's connection with its customers. Other bright spots included healthy growth in loyalty membership and rising demand for branded credit cards and gift cards.

Profitability challenges

Ulta Beauty posted a slight decline in its gross profit margin and a more significant drop in its operating margin in the second quarter. But while profitability has been falling for more than a year, this decrease was driven mostly by temporary issues. The company booked elevated expenses related to the opening of a new distribution center in California and in-store upgrades to the spa section, for example. An accounting rule change also reduced its profit.

Executives also pointed to "aggressive markdowns" as part of an inventory-clearing sale that pressured margins. However, the impact was minor and resulted in a far leaner inventory position heading into the key holiday selling season. That posture should allow plenty of room for new-product launches and sets up Ulta Beauty for healthier earnings in the back half of 2018.

New stores on the way

Executives affirmed their full-year outlook that calls for sales at existing locations to rise by about 7% this year. This forecast assumes that comp sales growth will accelerate for the first time in over a year during the third quarter. Ulta Beauty sees no reason to slow its physical store expansion, either. The retailer is on track to open 100 new locations this year, including entering Vermont, which would give it at least one store in every U.S. state. As of early August, Ulta operated 1,124 stores, but that could reach as many as 1,700 over time, management says.

Most of Ulta Beauty's 2018 new-store launches have already happened. That was a strategic decision by the leadership team, aimed at getting as many locations as possible up and running ahead of the major sales events around the holiday shopping months.

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Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Ulta Beauty. The Motley Fool has a disclosure policy.