Lookback: Wedgewood Partners 2019 Ulta Beauty (ULTA) Thesis

Alex Smith
·5 min read

If you are looking for the best ideas for your portfolio you may want to consider some of Wedgewood Partners top stock picks. Wedgewood Partners, an investment management firm, is betting on Ulta Beauty Inc. (NASDAQ:ULTA) stock. In its Q3 2019 investor letter – you can download a copy here – the firm discussed its investment thesis on Ulta Beauty Inc. (NASDAQ:ULTA) stock. Ulta Beauty Inc. (NASDAQ:ULTA) is a beauty salon company.

In October 2019, Wedgewood Partners had released its Q3 2019 investor letter. The investment firm trimmed its position in Ulta Beauty Inc. (NASDAQ:ULTA) stock in Q3 2019. The stock has posted a return of 20% in the trailing one year period, outperforming the S&P 500 Index which returned 14.2% in the same period. This suggests that the investment firm was wrong in its decision.

Wedgewood Partners fund posted a return of 0.39% in the third quarter of 2019, underperforming the S&P 500 Index which returned 1.87% in the same quarter. Let’s take a look at comments made by Wedgewood Partners about Ulta Beauty Inc. (NASDAQ:ULTA) in the Q3 2019 investor letter.

"Ulta Beauty was our top detractor during the quarter, following bleak commentary during the Company's latest earnings call and management’s subsequent reduced annual guidance for top and bottom-line performance, noting a slowing U.S. makeup category. Based on what management is seeing in their own stores as well as information from market research firms, growth in both mass cosmetics and the higher-priced prestige cosmetics has steadily declined over the last couple of years. The broad category, not specific to Ulta stores, put up strong growth figures in 2016 and into 2017. Those growth figures have hence slowed nearly continuously to the point where the Company is seeing figures (as of their earnings report in late August) indicating that the U.S. cosmetics category had turned negative, pointing to a volatile and sudden change. This seemed to take everyone by surprise, Wedgewood included, as no other peer had indicated a market slowdown to this extent in reports provided only a month prior.

Ulta has a diverse offering of non-makeup categories in skin care, hair care, fragrance, and bath, which are all producing strong, healthy gains. However, cosmetics accounts for approximately 50% of Ulta’s business and is one of the highest-margin categories, especially the prestige category, which has experienced a stronger slow-down than mass over the past couple of years. Ulta has a slightly stronger weighting to prestige in their offering. For many years there was an influx of innovations around multiple makeup behaviors, application techniques, and formulas. More recently, these innovations have slowed, and while they are still very important to the overall category, they are no longer driving the incremental growth of which Ulta was once the beneficiary, and unfortunately, new entrants have not yet replicated that excitement and growth.

Despite the slowing category growth and recent volatility which saw a swing to negative, Ulta has continued to gain share in this very fragmented industry. At their Investor Day last year, management noted that Ulta holds an approximate 7% market share of the vast $87 billion U.S. beauty products market and specifically, an approximate 20% share in cosmetics. They attribute their ability to continue taking share not only to their diverse offerings across price points but also to their strong loyalty program, which is now 33 million members who represent a vast majority of annual revenue. However, we cannot ignore the slowing sales growth in both the industry and Ulta Beauty and the resulting near-term volatility in revenue. At the same time, we are cognizant the Company will continue with planned investment initiatives to position themselves for future growth, which will likely weigh on operating earnings for a period of time. Therefore, we trimmed our holding to a minimum weighting during the quarter. Management – and Wedgewood – remain confident in the long-term outlook of the business. As we neared the end of the quarter and shortly after the close, we saw reports of substantial insider buying in Company stock, a typically strong positive indicator. While the years of mid-teens same store sales growth are likely behind them, Ulta continues to report industry-leading comp sales growth as well as growing their new store footprint at a mid-single-digit growth rate."

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In Q2 2020, the number of bullish hedge fund positions on Ulta Beauty Inc. (NASDAQ:ULTA) stock decreased by about 17% from the previous quarter (see the chart here), so a number of other hedge fund managers don't believe in ULTA's growth potential. Our calculations showed that Ulta Beauty Inc. (NASDAQ:ULTA) isn't ranked among the 30 most popular stocks among hedge funds.

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Video: Top 5 Stocks Among Hedge Funds

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Disclosure: None. This article is originally published at Insider Monkey.