Why Ulta Beauty’s Margins Contracted in 3Q17
Lower gross margin
Despite strong sales growth, Ulta Beauty’s (ULTA) gross as well as operating margin fell in fiscal 3Q17, which ended on October 28, 2017. The company’s gross margin fell about 110 basis points on a year-over-year basis to 36.7% in fiscal 3Q17. This decline was a result of the deleverage in merchandise margins.
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Operating margin contracted
Ulta Beauty’s operating margin contracted to 12.1% in fiscal 3Q17 from 12.4% in fiscal 3Q16. Despite lower selling, general, and administrative (or SG&A) expenses as a percentage of sales, the company’s operating margin contracted due to the new store and boutique activity. In fiscal 3Q17, the company opened 48 new stores, relocated two stores, and remodeled five stores. Pre-opening expenses as a percentage of sales expanded to 0.7% in fiscal 3Q17 compared to 0.6% in fiscal 3Q16.
SG&A expenses as a percentage of net sales decreased 90 basis points to 23.9% in fiscal 3Q17. This improvement was a result of leverage in corporate overhead and variable store expenses driven by cost efficiencies and higher sales volume. However, this improvement was partially offset by higher store labor expenses to support growth initiatives and charges associated with hurricanes.
Following its third-quarter performance, the company revised its operating margin expectation for full-year fiscal 2017. Ulta Beauty now expects its operating margin to be flat to up about ten basis points in fiscal 2017 compared to the previous year. The company previously expected operating margin to expand by 20 to 30 basis points in fiscal 2017.
The company expects its operating margin to improve in the coming years and plans to reach its goal of 15% by the end of 2019. The company expects its operating margin to benefit from rent and occupancy leverage, supply chain efficiencies, more efficient distribution centers and systems, and corporate overhead savings.
We’ll look at Ulta Beauty’s valuation in the concluding part of this series.