Ulta Beauty’s Correction Is Overdue

It is true that Ms. Dillon led the company to successes. Revenue has grown at an average annual rate of 18.5% since the year she became CEO through 2019. The choice for successor isn’t so surprising—Mr. Kimbell is a familiar candidate, having joined Ulta in 2014 as chief marketing officer. But the timing may have caught investors off guard.

While Ms. Dillon will stay on as an executive chair for a year after she steps down in June, Mr. Kimbell is taking over at a precarious time for the beauty industry. Makeup was already a shrinking category in 2019 before the pandemic, with industrywide revenue declining for the first time in about a decade, according to industry research firm NPD Group. After several years of strong growth, boosted by social media and innovative new products, the cosmetics industry seemed to lose momentum.

Nevertheless, Ulta Beauty’s 2020 results show its strong grasp on market share. For the fiscal year ended Jan. 30, the company saw its sales decline 16.8%, a milder drop than the 19% decline that the overall U.S. prestige beauty industry saw in 2020, according to NPD Group. While consumers bought less makeup, Ulta made up for some of those losses with so-called self-care categories such as skin care, fragrance and bath products, all of which saw increases in the holiday quarter compared to a year earlier.

Ulta Beauty gave muted guidance for the current fiscal year, expecting revenue to fall compared to pre-pandemic 2019. Company executives are confident that consumers will come back to buy makeup, the largest category and the one that most underperformed in 2020, as life returns to normal. They just aren’t sure when, especially as it remains unclear when people will stop wearing masks. Even after vaccinations are well under way, consumers may not immediately feel comfortable reverting back to pre-pandemic behavior.

There are some bright spots for Ulta Beauty and specialty beauty retailers. Many department stores have closed down or have lost market share, for example. Ulta Beauty’s partnership with Target is well-timed, as shoppers have directed most of their foot traffic to essential retailers.

But there is also good reason for caution, given that makeup was already a declining market before the pandemic. Another potential concern is that customers have become familiar with online shopping for beauty products on places like Amazon.com. And then there is rival Sephora, which has an agreement to set up shop inside Kohl’s department stores beginning this year. Roughly 76% of the initial Sephora stores inside Kohl’s have a competing Ulta Beauty within 3 miles, according to analysis from Oppenheimer & Co.

Given some of these uncertainties and the fact that its operating margins have declined since 2016, the price correction Ulta Beauty saw today was overdue. Before the Thursday earnings call, its shares were trading at 38 times forward earnings, well above its five-year average of 27 times.

Perhaps it took a management shake-up for investors to realize just how uncertain prospects actually are for the beauty industry.

Write to Jinjoo Lee at jinjoo.lee@wsj.com