Ulta Salon, Cosmetics & Fragrance Inc. (NASDAQ:ULTA) currently is ranked No. 2 on Investor’s Business Daily’s list of the 50 best stocks. Ulta’s business is booming. Last quarter, sales and earnings increased 23% and 73% year-over-year, respectively. Fourth-quarter earnings, expected Dec. 1, should be much the same.
Despite all the good news, investors might want to ditch the beauty salon business and focus exclusively on the hair care and beauty products — and more importantly, the stock — offered by Sally Beauty Holdings (NYSE:SBH). The former Alberto Culver subsidiary might have a lot of debt, but it’s a much better buy. I’ll explain why.
Normally, I’m not keen on investing in companies whose level of debt is unusually high. However, I’m willing to make an exception for Sally Beauty Holdings because of its profitability. Since Sally was spun out of Alberto Culver in November 2006, its gross margins have increased 300 basis points to 48.8% and its operating margins 610 basis points to 13.7%. These are substantially higher than ULTA’s margins, which are at their highest levels ever.
Sally makes 44% more than Ulta for every dollar of revenue. Therefore, as long as Sally continues to grow revenues 5% to 10% per year, the debt problem will take care of itself.
I’ve already shown that Sally is more profitable. However, margins aren’t everything. Growth also is meaningful, so why don’t we have a look at that side of the coin?
Everything about Ulta suggests it’s a growth company. Revenues have grown an average of 20% annually over the past five years. Sally, on the other hand, has plodded along at 6% annually.
Using their trailing 12-month revenue numbers, let’s figure out how much money each company will be earning five years from now. At 20% revenue growth, Ulta’s revenues in 2016 would be $4 billion. Sally’s revenue in 2016, based on 6% growth, would be $4.4 billion. Assuming the same margins as today, Sally would earn $599 million in 2016 — $161 million more than Ulta.
Fans of Ulta could argue that its operating margin will be higher than 9.5% in five years given its current growth in earnings. That’s true, but the same can be said for Sally, which actually has increased margins since 2006 at a rate equal to or slightly better than Ulta.