Browsing through Twitter / X, I often see people posting about “buy-the-dip” candidates. While this is not necessarily the case for energy stocks (where as my readers and especially members know, I have a positive opinion about), in the recent past more and more consumer discretionary stocks have been presented. The main arguments are always the same – they are cheap(er) now! I have some doubts that it’s time to rush in.

Summary and key takeaways from today’s Weekly
– Buying the dip is not a no-brainer.
– Even though high-quality companies can have great histories, one needs to assess the current situation and the further outlook.
– In essence, even huge price drops among consumer discretionaries can be justified.

Before we start, consumer discretionary stocks are not to be confused with those pretend always safe and recession resistant (“boring”) consumer defensive stocks.

The former – today’s topic – tend to be way more cyclical because their products are nice to have or enjoy when the economy is doing well, though often dispensable in times of stress or even hardship. Think of high(er) price goods like coffees to go or restaurants, travel, more expensive clothes or any other type of everyday luxury one enjoys as an average Joe that’s beyond the really needed necessities.

Consumer defensive stocks barely fall by 40–50% or the like assuming their business is not broken. Consumer discretionaries, though, can do just that, even easily.

I am not talking about luxury here, though this once “it never goes down because the rich always have money” sector, also has been hit pretty hard, as I had to experience myself with my ill-timed pick of Burberry (ISIN: GB0031743007, Ticker: BRBY) which like I feared continues to fall further after I’ve pulled the brake (see my Weekly where I review this case here).

Consumer defensive covers all the basics like food, beverages, household goods and also tobacco and tends to be not that exciting on the upside, but clearly more balanced and defensive in a recession.

So in a nutshell, consumer discretionaries sit somewhere in-between both extremes.

The big advantage and likely the reason why many such buy the dip posts appear is that their expected returns are higher. Not necessarily due to higher growth, but due to margin and volume expansion when coming out of a bottom.

But if the bottom hasn’t been marked, yet, the losses can be painful, even despite having already seen corrections of 20% or more.

Today, I want to have a quick-check look at three such often mentioned pretend buy the dip candidates, namely:

• Ulta Beauty (ISIN: US90384S3031, Ticker: ULTA)
• Lululemon Atheltica (ISIN: US5500211090, Ticker: lulu)
• Starbucks (ISIN: US8552441094, Ticker: SBUX)

All three have had impressive periods of high-growth and multi-bagger returns for shareholders. However recently, they all have been struggling, igniting greed inside of those falling-knife catchers.

After having checked them, I think it is too early to strike.

With my risks-first approach (paired with high upside), I am able to find stocks with great returns.

Currently, many of my ideas are going through a correction (without altering the underlying theses) while the indexes as well as ETFs are dominated and determined mainly by a few big tech stocks. My ideas have been at times even way ahead compared to the benchmarks.

I am convinced that this will be case again soon, because the valuations and organic growth stories are very attractive.

Join me and my members on our journey to beat the markets!

^{both as per 19 June 2024 market close – since August 2022}

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Ulta Beauty

Ulta Beauty is a US-focussed specialty beauty retailer, founded in 1990.

The company offers several branded and private label beauty products like cosmetics, fragrance, hair- and skincare, bath and body products, professional hair products and salon styling tools through its Ulta Beauty stores, shop-in-shops, Ulta.com website, and its app.

It also offers certain beauty services like making hair or makeup at its stores. 

Looking at the long-term charts, we can see the impressive growth story behind Ulta, coming from 25 USD and rising almost up to 600 USD a share.

So, a more than 20-bagger from start to top.

However, it came down from its all-time high in March 2024 – which was roughly a quarter ago – by 32% as of writing. This is more than just a small correction, especially when the business has been seen as high-quality before.

Nothing “dips” by 30% without a reason.

This awakens desire to catch the bottom in order to participate in the next upswing.

Being a growth story with increasing sales 3x, earnings 5x and cash flows 3.5x over the last ten years, Ulta was valued with a higher multiple than common slow-growth retailers are.

Above, I have put Wal-Mart (ISIN: US9311421039, Ticker: WMT) and Ulta into a chart, not because they are competitors, but only to showcase the big difference in valuation multiples between a defensive and the high-growth business.

By the way and just for the sake of completeness, WMT is trading at an all-time high as a defensive business.

Looking at the sales multiple above and the earnings multiple below, we can see that Ulta is indeed trading near its ten-year lows valuation-wise. A PE ratio of 15x for this debt-free business looks like a steal.

The problem is that the growth story has slowed down remarkably.

Below, you can see the yearly growth rates with the two lockdown-years being outliers. But the 15–20% p.a. growth years seem to be behind us, at least for now.

The recent Q1 earnings announcement showed only +1.6% comparable sales growth – i.e. almost flat when you are used to double-digit rates and practically negative when factoring in even the official inflation rate. Comparable means on an equal store count basis.

Including store growth, total sales went up by 3.5% which is more than double the first figure, but still below historical norms.

This is a new ten-year trough, excluding FY21 with the forced store closures.

It is safe to say that – no matter how good the business has been performing in the past – if consumers (the middle-class) are spending less due to inflation or even lost jobs, such a business won’t be flourishing.

Period.

That’s the reason this growth story is on full brakes for now. It is of course not completely over. But a 15x PE, respectively a c. 15–20x free cash flow multiple are still pricing in a modest growth rate.

The rule of thumb is, 10x is a no-growth case.

So in order to justify the current valuation, Ulta must show and sustain some growth – ideally more than what was presented with the last set of results, because 3.5% is on the verge of fair value for me (for a 15x multiple).

It is not sufficient just to look at a price or valuation chart – the development and outlook of the underlying business must be assessed.

This does not mean the tide cannot beging to turn at some point, pulling the stock and the valuation multiple higher again. I could be completely wrong with my assessment.

I am trying to look not only at chances, but also at risks.

As there are cheaper competitors like e.l.f. Beauty (ISIN: US26856L1035, Ticker: ELF) or just private-label alternatives everywhere else, it is likely fair to assume that at least a part of the target audience is not spending as aggressively as in the past.

I think it speaks for itself that e.l.f. Beauty is not far from its all-time highs with sales growing by 47% and 77% in the last two fiscal years (with only half the market cap), while another high-price competitor like Estée Lauder (ISIN: US5184391044, Ticker: EL) has also been suffering pretty much.

I see a realistic risk of another 30% drop for Ulta, given that margins hold up under the assumption that it does not return to higher growth rates or even dips to zero growth.

Lululemon

Unlike Ulta, Lululemon is operating worldwide, thus having an international business, however, the US are the main contributor with about 72% of total sales.

The 1998-founded company designs and sells athletic apparel, footwear, and accessories under the lululemon brand for women and men. The best-known product are likely the (for me expensive-looking) skin-tight yoga pants.

lulu is a Canadian company, but its stock is also traded in the USA.

Coming from 17 USD and rising to above 500 USD, Lulu has been even a former 30-bagger during the same timeframe like Ulta Beaty (since 2007).

However, since the peak on year’s end 2023, lulu’s stock crashed even below 300 USD or by about 40% in less than half a year only!

Isn’t it interesting to see such movements when the majority of retail investors and media headlines are celebrating new all-time highs for the indexes?

Back to lulu, the playbook is similar to Ulta, even though in a different niche.

Growth has been strong with double digit rates, however, especially after the lockdown and yoga-from-home period, the business started to experience a remarkable slow-down.

Below, we can see the development of the yearly sales growth rates for the entire company.

And now for North America, so you know what’s up.

While the last fiscal year was nothing to complain about (based on total sales growth), the start into the new year was tough and disappointing.

Fourth-quarter sales came in at 16% for the winter holiday season which was below the full-year’s rate. But what spooked investors was the outlook with only 9–10% for 2024 – about half the growth compared to full 2023.

With even weaker sales growth from the core market.

As certain investors have been used to pay silly multiples in excess of 50x earnings, it is no wonder the stock crashed massively with the new guidance.

Small shifts in the growth rate are already good enough to cause a richly valued stock to correct. But when the pace slows down remarkably, the correction is usually even more painful. Luckily, with the latest Q1 results from a few weeks ago, the fear that the business could be slowing down even more, did prove to be overblown.

Net sales increased by 10% and the outlook was confirmed. On top, Lulu is buying back some shares and it has a debt free balance sheet.

Another aspect is that new competitors are being said to emerge. I’ve never heard their names before and as I am not familiar neither with lulu’s assortment nor with this special niche, I cannot comment more on that. Lulu seems to be a well established brand with a strong fanbase.

But will it stay in business or continue to grow aggressively?

I don’t know, but let’s play it in case of doubt for the defendant. As Lulu’s stock is valued with a PE ratio of 25x and an EV / FCF of about give or take 20x, I’m inclined to say that this company is fairly valued – putting two blind eyes on it. At least, it does not look like a dramatic undervaluation worth the risk of engaging here.

I think I will watch this stock, but there’s no need to rush in here, as another guidance correction to the downside would likely send the stock down well below the current level.

Again, I could be wrong, but there’s not decent enough margin of safety.

Starbucks

This is more the darling of the crowd.

I do not need to explain what this company is doing. What needs some explanation though, is why I think that this is by no means a must-buy opportunity.

Let’s start with the long-term chart like above. Starbucks went up by a factor of around 10x in the same timeframe like Ulta and Lulu, but it’s the only one paying a dividend, so the total return is somewhat higher.

All in all, it is a success story and a multi-bagger for long-term investors.

The stock marked its all-time high already in 2021 and from the recent lower top above 100 USD, Starbucks experienced a 20% drop to levels the stock had already seen in 2019.

Not a brutal crash, but a noticeable correction.

Besides being a pure stock price growth story, it is also a favorite among the dividend investing crowd. Not due to its 2.7% dividend yield, but due to being a so-called dividend growth stock with yearly dividend increases.

So more a mixed case, however, with a way bigger fanbase.

Sales growth over the last ten years was a bit less impressive, but a bit more than a double is nothing to complain about. The same applies for operating earnings which also doubled.

Growth rates have been heavily fluctuating. Sales increased by about 10% over the last two recent years.

However, the latest Q1 results send the stock into the basement with a double-digit drop.

The reason?

Not only a slow-down, but a full step on the brake with both feet.

Comparable sales declined by 4% in total and 3% in the US (6% internationally). If there’s one thing you do not want to hear as an investor in growth stories it is a shrinking business.

Total sales after new store openings were still down by 2%.

Knowing that Starbucks historically has been valued with a high multiple, this is a toxic mix. Long-term valuation charts are not useful here as there are some years with massive deviations. Hence, I am describing it.

Free cash flow is about 3.5–4 bn. USD. The market cap before the drop was around 100 bn. USD, so a 25–30x multiple. This might have been tolerated as long as the business grew by 10–15%, but a operational decline cannot be awarded with such an excessive number.

As a reminder, perpetually shrinking businesses like tobacco, are valued a single digit multiples.

While I do not think that Starbucks will be a perpetually declining business from now, the headwinds are without a doubt better to be taken seriously.

During the last conference call, the guidance was massively lowered.

• global sales low single-digits (from +7–10%)
• on a comparable basis low single-digit decline (!) to flat (from +4–6%)
• earnings per share flat to low single digits (from +15–20%)

To be honest, I am even surprised the stock did not crater really hard based on these new facts an investor has to deal with (and not: “the history has been so great”).

Even assuming Starbucks does not deteriorate further and achieves a FCF of 3–3.5 bn. USD, the current market cap of 92 bn. USD looks too high. As the only one from today’s group, SBUX also has net financial debt of ~12 bn. USD for an enterprise value of 105 bn. USD.

That is definitely too much, by no means taking into account any sort of a new operating environment (shrinkage instead of growth).

Dividend hunters will likely continue to love this stock, but for me is is way overpriced – like the sugared coffees.

Conclusion

Buying the dip is not a no-brainer.

Even though high-quality companies can have great histories, one needs to assess the current situation and the further outlook.

In essence, even huge price drops among consumer discretionaries can be justified.

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