Last Friday, on his show Mad Money, Jim Cramer asked what had happened to Ulta Salon Cosmetics & Fragrance (ULTA) . After hitting a fresh 52-week high, the stock is down 37 straight points (about 13%).
I think I know why the stock is down.
Back in February an anonymous group of short-sellers published an 81-page report on Ulta. Based on their analysis, they believe the stock is worth between $84 and $92 per share. Undoubtedly this group, which claims to have 25 years experience on Wall Street, has a huge short position in the stock and "leaked" their report on the Internet to jam the stock down.
The short-sellers claim the stock is overvalued, the store base has reached a saturation point, store quality has deteriorated dramatically, new stores are cannibalizing existing stores and same-store figures are overstated.
After the report was released, the stock got knocked down and eventually bottomed out at $150, which, ironically, was a great place to buy.
On March 10, Ulta reported fourth-quarter results. Revenue rose 21% to $1.27 billion. Same store sales rose 12.5%, well above the Street estimate of 9.5%.
Management guided for fiscal year 2017 (ending January) same-store sales in the range of 8-10% and forecasted total sales rising in the mid- to high-teens. E-commerce sales are expected to grow 40% and the company plans to open an additional 100 stores.
That's all the ammo the bulls needed. With the stock touching $150 and a blowout fourth quarter, the shorts got their lungs ripped out. The stock flew up, powered in part by the huge short position.
Then, if a blowout quarter wasn't enough pain, on April 7, Standard & Poor's said it would replace Tenet Healthcare (THC) with Ulta in the S&P 500. Index funds needed to add ULTA to their portfolios pronto. That's the stock market equivalent of getting hit upside the head with a 2x4. Smack!
According to the Nasdaq, there were more than 1.9 million shares sold short at the end of July and 1.7 million in mid-August. It would take between 4.3 and 3.8 days, respectively, to cover those positions.
After the second-quarter report, there were even more shares sold short. As of Aug. 31, 2.3 million shares were short.
But there is a reason for all this short activity.
On Aug. 25, Ulta reported second-quarter results. Net sales rose 22% to $1,069.2 million from $877.0 million in the second quarter of fiscal 2015. However inventory grew 32% to $930.2 million, outstripping sales growth. The additional inventory may be related to new store openings. In the second quarter, the company opened 24 new stores (vs. 20 in 2015), relocated one and renovated two.
In the second quarter, accounts payable increased 32%, again, faster than sales. That could indicate the company is relying on credit provided by its suppliers and has slowed down paying for merchandise.
Furthermore, the midpoint of third-quarter guidance sees revenue at $1.072 billion and earnings per share of $1.27. To some investors that guidance was slightly disappointing, as many had expected EPS closer to $1.30 and higher revenue.
For those three reasons, short-sellers are attracted to the stock. And to me, those are pretty good reasons.
With inventory and accounts payable growing faster than sales and somewhat disappointing third-quarter guidance, I would be cautious. Ulta is set to report its third quarter on Dec. 1. In my opinion, the stock is not done going down.