The Ratings Game: Ulta Beauty welcomes Kardashians, but margins give analysts pause

Ulta Beauty Inc. is happy to see Kylie Jenner’s makeup lining store shelves, but the new line is not helping its botton line.

Ulta’s gross margins have flattened and analysts are concerned which way they’ll go from here.

Kylie Cosmetics launched in Ulta ULTA, -13.13%   stores on November 17 with 28 items, and online with fewer products. For the holidays, the retailer has also launched four Kim Kardashian West fragrances in stores.

Both members of the extended Kardashian family have promoted the merchandise to their hundreds of millions of Instagram followers and Jenner appeared at a Houston Ulta to support the launch.

However, gross margins for the quarter were flat compared with last year at 36.7%. Chief Financial Officer Scott Settersten explained the many reasons why on the earnings call.

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“Some of the factors driving this deleverage were the same dynamics we’ve been experiencing all year, including a mix of e-commerce sales, the mix of lower-margin prestige brands, investments in our salon business, and supply chain deleverage driven by the Fresno distribution center opening, as well as higher freight costs, which weighed on the P&L by about 10 basis points to 15 basis points as we called out at our analyst day,” he said, according to a FactSet transcript. Ulta’s analyst and investor day took place on November 8.

Ulta hosted a clearance event, which he said pressured margins “more than planned.”

“[W]e believe this is somewhat confusing given that management would have presumably had an idea about this pressure when they originally guided 3Q gross margins to see good leverage that the 2Q EPS report,” wrote Instinet in a note. “This does raise a fair question around management’s visibility into gross margin dynamics.”

Stifel analysts also called out the margin miss, saying it’s “notable” because the event was previously highlighted “and we believe this indicates continued volatility in gross margin.”

Instinet rates Ulta shares a buy and has a $305 price target, or about 17% above its current trading level. Stifel rates Ulta hold with a price target of $270.

Raymond James said the margins did disappoint, but analysts were encouraged by the “competitive but stable” promotional environment that executives discussed. Raymond James rates Ulta market perform.

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Part of the reason for Stifel’s hold rating is the crowded beauty field, analysts said, “with near-term concerns centered on slowing company and category growth and fears of increased competition, likely resulting in rising costs of doing business.”

Competition is coming from many rivals, with Ulta’s Chief Executive Mary Dillon saying on the call that the company has started an emerging brands team that will pinpoint “new and often digitally-native brands” that can become partners and other retailers taking steps to grow their share of beauty market business.

On Thursday night, Walgreens Boots Alliance Inc. WBA, -2.11%   launched a partnership with beauty subscription service Birchbox at an event in New York City attended by the media and influencers.

Target Corp. TGT, -2.49%   has its own Beauty Box subscription service, and there’s further competition from Sephora. And the list continues.

“While the company continues to execute well and gain meaningful market share in a highly competitive environment, we believe valuation reflects this and given the uncertain margin outlook we are somewhat reticent to get more constructive on the name at this point,” wrote Raymond James.

All of these factors aside, Cowen analysts are still bullish about Ulta, rating shares outperform with a $340 price target based on its format and merchandise assortment, which mixes high and low brands, its loyalty program, and vendor relationships.

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“We also believe Ulta is positioning itself to be at the center of a larger purpose – the company is creating a digital ecosystem and platform for beauty enthusiasts that connects, interprets and forecasts personalized buying habits,” Cowen wrote.

That sort of ‘connected’ customer engagement is key for retailers today, said Cowen.

Ulta shares tanked nearly 10% in Friday trading after the company warned that earnings will miss fourth-quarter estimates. Ulta expects earnings in the range of $3.50 to $3.55 versus the FactSet consensus of $3.62 at the end of November.

Ulta shares sank 13% in Friday trading, but have gained 13.8% for the year to date while the S&P 500 index SPX, -2.33%   is down 1.5% for the period.

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