No Makeover Needed

 | Dec 27, 2012 | 9:00 AM EST
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In the last few days, investors have been freaking out about soft holiday sales. A report by MasterCard's SpendingPulse said sales for the two months before Christmas were up just 0.7%. The news caused investors to hit the eject button on the retail sector. While we won't know the results until all the retailers have reported one name I follow, Ulta Salon, Cosmetics & Fragrance (ULTA), is on track to report a strong holiday quarter. Cosmetics tend to sell well in any economic environment, and I think ULTA will end up a big winner this season.

When I wrote about ULTA in June, the stock was at $95.05 -- basically the same place it is now. But I still think ULTA is one of the most exciting names in the specialty retail space and should be able to reach $120/share.

ULTA is an exciting play in the specialty retail space because the stores are located in off-mall locations and have become destinations for consumers. The stores are an average of 10,000 square feet and carry as many as 20,000 products. ULTA has limited competition and is building new stores at a furious pace. Finally, ULTA allows the big cosmetics brands to build "brand boutiques", which allows the majors to showcase their entire cosmetics line, further enhancing the store's destination image.

For the third quarter (October), the company reported earnings per share of $0.59. Revenue rose 22.4% to $503 million. Same store sales grew 8.4% (on top of last years 9.6%). Gross margin increased 60 basis points to 36.7% from 36.1%.

For the fourth quarter, the company forecast sales of $742 million to $754 million and same store sales between 5% and 7%. Management is accelerating new store openings. The company plans to grow square footage by 22% next year, which works out to about 125 new stores.

According to ThomsonOne, the Street consensus is for fiscal year revenue of $2.2 billion and earnings per share of $2.66. With an additional 125 new stores, analysts forecast sales will grow 20% to $2.6 billion. Earnings will grow 28% to $3.40. Because of the aggressive growth path, investors have been willing to pay a significant premium for the shares.

As one of the few high growth retailers out there, I think investors would be willing to pay 35x to 37x forward earnings for the shares. The company has been able to consistently beat forecasts, so it's likely the $3.40 fiscal 2014 estimate is low. For example, this year, the company beat the Street estimate by $0.10. For momentum lovers, that's a big deal. Given that, I can see UTLA hitting $120 before this time next year. 

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volatility is quite low here, and we could see some downsides here in the short term. ...



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