Issue #48: A recession-proof retailer with rapid growth and a discounted tech titan

Ulta Beauty is the largest specialty retailer in a traditionally recession-resistant business. The Company has bounced back from COVID-driven shutdowns in 2020 and resumed a steady growth trajectory.

Adobe is a blue-chip tech company with absolute dominance in its niche, long-term growth potential, strong profit margins, and an impeccable balance sheet. Share prices have dropped due to an overall tech selloff and short-term growth concerns.


Ulta Beauty, Inc. ($ULTA)

Source: tradingview.com

Summary:

  • Share price at the time of writing: $359.11
  • Ulta Beauty is the largest beauty retailer in the US, offering cosmetics, fragrance, haircare, and skincare products and salon services. 
  • $ULTA will add 50 new stores a year through 2024, in a bid to increase market share and revenue.
  • $ULTA has an operating margin of 15.75%, unusually high for a retail business.
  • Revenues and earnings were heavily affected by store closings during the COVID pandemic but have bounced back strongly and resumed a growth trend.

What they do:

Ulta Beauty is a beauty products and services retailer. With 1296 stores and a presence in all 50 states, they are the largest of their type in the US.

Ulta stores and their website and mobile app offer 25,000 products from 600 brands. A typical store averages 10,000 square feet with a 950 square foot dedicated salon space.

$ULTA offers a wide product selection including prestige and mass cosmetics, fragrance, haircare, prestige and mass skincare, bath and body products, professional hair products, and salon styling tools. They offer a full-service salon in every store featuring hair, skin, makeup, and brow services. 

Ulta has opened โ€œUlta Beauty at Targetโ€ at 100 Target locations across the country, exposing the brand to a new range of shoppers.

ULTA also offers a dedicated e-commerce website, with the ability to order online with home delivery, in-store pickup, or curbside pickup.

Ulta offers the Ultamate Rewards loyalty program, which has almost 36 million members nationwide.

What we learned from social media patterns:

$ULTA is hardly a trending stock on social media, but the stock saw a spike in mentions in early December.

That December 7 spike coincided with a surge in the stockโ€™s price from $370 on Dec. 1 to $412 on Dec. 8. Shares promptly dropped back, bottoming at $365 on Dec. 12 before spiking again to $418.75 on Jan 4, and attention dropped.

This see-saw action is part of an unusual pattern that $ULTA shares have exhibited for the last 6 months:

Since August 2020 the stock has peaked at or above $410 on five separate occasions, dropping again to the $355-$370 level after the peak.

This pattern does not follow any news cycle or change in the stockโ€™s fundamentals and is difficult to explain outside the context of overall market fluctuations and changing overall investor sentiment. The stock does seem to have established a support level in the $365-$370 range, where it is now – which social media commentators might have not noticed.

Notable comment from Reddit:

โ€œUlta will always trade rich; itโ€™s a Becky stock* that literally all the women in my life shop at. Itโ€™s my wifeโ€™s and my best friendโ€™s wifeโ€™s #1 holding and has doubled up for them since she bought it last year. Also, they will soon be opening their target locations which will be interesting and my wife is very excited for that from an investment and personal experience perspective.โ€

– ionlypwn

 *A โ€œBecky portfolioโ€ contains companies catering to women of the middle class and above.

Smart Money Signal: Institutions hold 92.56% of the $ULTA float, with The Vanguard Group and Blackrock leading with a combined total of 9.6 million shares.

Why $ULTA could be valuable:

The U.S. beauty and personal care products market is expected to show a 5.12% CAGR through 2027.

$ULTA is the single largest retailer in the industry and is moving to increase its market share by opening new stores, entering partnerships with major retailers like Target, and expanding its e-commerce channel. 

Because Ulta is a specialty retailer with a single focus, they can adjust their product mix, presentation, and advertising to match evolving trends more effectively than department stores or other non-specialist outlets. Thatโ€™s a significant advantage in a heavily trend-driven business.

$ULTA has shown solid, steady growth, aside from the impact of COVID-19. Recently released Q3 results for FY2021 were up 28.6% from the COVID-hit Q3 2020, but they were also up 14.3% over the pre-COVID Q3 2019, indicating that the Company is back on a growth track.

The beauty industry is traditionally recession-resistant, a serious consideration in an arguably overvalued market with the Fed beginning to tighten rates.

$ULTAโ€™s operating margin and return on equity are very strong for a retail business, at 15.75% and 45.19% respectively. That gives the Company the ability to resist price increases while maintaining profitability even in an inflationary market. That can have a negative impact on short-term results but it can boost market share in the long term.

$ULTA has beaten analyst consensus earnings estimates by wide margins for four consecutive quarters:

25 analysts currently cover $ULTA, with a consensus โ€œBuyโ€ rating and an average price target of $453.80, 21% higher than the current price.

What the risks are:

1๏ธโƒฃCOVID isnโ€™t done. COVID-related store closings and movement restrictions in 2020 had a dramatic impact on $ULTA results. Any resurgence in the pandemic could have a similar impact.

2๏ธโƒฃ $ULTAโ€™s business is trend-driven. Ulta Beauty depends on its ability to anticipate and lead beauty trends and have the appropriate products and services ready when consumers want them. Failure to accurately anticipate trends could affect results.

3๏ธโƒฃ The beauty industry is highly competitive. Ulta is the leading retailer in its niche but that position is under constant challenge from other physical and online retailers. There is no guarantee that the Company will be able to maintain and expand its market share.

Bottom line: $ULTA is a dominant retailer in a recession-resistant niche, with excellent fundamentals and a strong balance sheet. Revenues and earnings have recovered strongly from the COVID pandemic and resumed a strong growth trend.


Adobe Inc. ($ADBE)

 

Source: tradingview.com

Summary:

  • Share price at the time of writing: $510.85
  • Adobe is a producer of software aimed at creative functions like photo editing, video editing, design, document management, and more. 
  • Adobe enjoys a high level of loyalty among creative professionals, and constant upgrades place product accessibility and functionality at the front of the pack.
  • $ADBE has very strong margins, steady revenue and earnings growth, and a dominant competitive position.
  • Shares have been hit hard by the general selloff in tech stocks and conservative 2022 guidance, dropping the valuation to accessible levels.

What they do:

Adobe is a diversified global software company. Its products and services are used by creative professionals, including video and photo editors, developers and designers, content creators, knowledge workers, and many more.

Adobe products are sold on cloud-based platforms as a Software as a Service (SaaS) model or a managed services model. They are also available on term subscription and pay-for-use models.

Adobe operates in three business segments.

  • The Digital Media segment is built around Creative Cloud, a subscription-based business giving access to Photoshop, Illustrator, Premiere Pro, and many other established Adobe products. 
  • The Digital Experience segment is a comprehensive suite of enterprise-oriented customer experience management solutions, including real-time data and analytics, campaign management, content management, and much more.
  • The Publishing and Advertising segment offers Advertising Cloud, which enables the delivery of video, display, and search advertising, along with legacy publishing solutions like Adobe PDF and PostScript.

In 2020 the Digital Media segment provided 75.8% of revenues, with Digital Experience providing 22.9% and Advertising and Publishing bringing in 1.3%.

The products delivered by these segments are available worldwide and on virtually all existing platforms and devices.

What we learned from social media discussion:

$ADBE showed a spike in social media activity in mid-December, coinciding with the release of Q4 2021 and FY 2021 financial results..

That same release triggered a rapid selloff in the stock, pushing it from $658.30 on Dec. 13 to $549.77 on Dec. 20, a 16.5% decline. Much of the buzz was spiked by relatively modest 2022 guidance, which projected increases in revenue and profit but less aggressive increases than analysts had projected.

That is arguably a weak reason for a 16% plunge, but it occurred against the backdrop of a general selloff in tech stocks. In that environment, any signs of actual or potential weakness can send investors rushing for the exits.

Notable comments from Reddit:

โ€œAdobe is the sole be-all and end-all in graphic design and general digital design. Their moat is akin to Microsoft. Iโ€™m not as familiar with Autodesk but I believe Adobe is one of the strongest companies in the world and is priced as such.โ€

– CptnAwesom3

โ€œADBE was hit significantly harder than most of the market on Friday, in large part because of woefully disappointing (and not entirely unexpected) results from DocuSign. Whether this was a knee-jerk reaction that came from human beings or purely the work of algos, the significant dip represents an opportunity for those who see ADBE as a larger and significantly more diversified business than DOCU, operating in spaces that have weathered the pandemic and even prospered quite a bit.โ€ฆ

โ€ฆThis feels a lot like a gift.โ€

– BDRBDRBDR

Smart Money Signal: Ken Fisher of Fisher Investments holds 6.43 million shares of $ADBE, and has bought for 13 consecutive quarters without a sale. ????

Why $ADBE could be valuable:

The creative software market is expected to show a 5.15% CAGR through 2026.

Source: Statista

Adobe is the dominant player in the market and has a strong competitive moat. Its products are essential tools for their users. Existing users would require serious effort and investment to switch platforms and new users have a strong incentive to learn and adopt industry-standard platforms.

Adobeโ€™s bundled services are difficult for competitors to match.

A competitor may produce one software package thatโ€™s competitive with an Adobe product, but a user can subscribe to Adobe Creative Cloud for $52.99/month and have access to Illustrator, Photoshop, Premiere Pro, AfterEffects, InDesign, Dreamweaver, Audition, Adobe XD, and more, all designed for interoperability. Thatโ€™s a huge challenge for any potential competitor.

Adobe led the curve in cloud migration and continually upgrades the functionality and accessibility of its services.

$ADBE has a strong balance sheet with more cash than debt. Operating margin and ROE are exceptional at 36.76% and 34.37%. That means strong cash flow and abundant resources to invest in R&D and acquisitions. Free cash flow has grown 284% in the last 5 years and $ADBE has bought back 1% of its outstanding shares.

The Companyโ€™s strong cash position, dominant competitive status, and high margins place it in an ideal position to weather an inflationary period or a serious recession.

31 analysts currently cover Adobe, with 11 rating it โ€œStrong Buyโ€, 14 saying โ€œBuyโ€, and 6 saying โ€œHoldโ€. The average price target is $664.36, 28.5% above the current price.

The recent selloff in Adobe shares is driven by factors that have little or no bearing on the long-term health of the Company. $ADBEโ€™s revenue and earnings guidance for 2022 was below analyst estimates, but the Company has a history of conservative guidance. UBS analysts issued a report suggesting that revenue and earnings growth could be weak because customers have pulled 2022 planned spending forward into 2021. That could produce a temporary growth slump but would have little impact on longer-term growth prospects.

$ADBE is not a cheap stock: its forward P/E is 39.68, the PEG ratio is 2.05, and the price-to-sales ratio is 18.04. It is, however, a high-quality company, combining blue-chip stability with tech growth potential. Quality comes with a premium price tag.

What the risks are:

1๏ธโƒฃ The Digital Experience Segment may fail to live up to expectations. Adobe has invested substantial resources in the development of the Digital Experience segment, which moves outside the Companyโ€™s traditional โ€œgated communityโ€ in the creative sector. If those investments fail to generate the expected returns, growth could suffer.

2๏ธโƒฃ Data security lapses could affect the Companyโ€™s reputation and position. Like any cloud-based Company, Adobe stores large amounts of intellectual property and confidential customer data. Security lapses could cause legal liability issues and undermine results.

3๏ธโƒฃ Privacy concerns could affect the Digital Experience segment. Adobeโ€™s digital experience products rely heavily on the use of customer data to refine customer relationships. Restrictions on the collection and use of customer data could make these products less desirable.

Bottom line: $ADBE is a blue-chip tech company with an impeccable balance sheet, strong margins, and a solid competitive position. Short-term results may not always meet expectations and any company is vulnerable to a market selloff, but there are few tech companies with this level of long-term fundamental strength.

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