Warren Buffett and Berkshire Hathaway have had a surprisingly muted year so far in 2024, at least when it comes to buying stocks. With the market priced at unusually high levels, Buffett has done little buying and has actually sold off several of his long-term holdings.
One surprising new position Berkshire has taken on, though, is a recently announced stake of 690,000 shares in prestige beauty retailer Ulta Beauty (NASDAQ:ULTA). Why is Buffett buying Ulta, and can the stock become a winner for Berkshire Hathaway?
A Look at Ulta’s Moat
The first factor that may have attracted Buffett to Ulta is the company’s strong position within its market.
Ulta operates just under 1,400 stores nationwide, providing it with a massive presence in brick-and-mortar beauty retail.
Even though rival chain Sephora is rapidly opening new locations in a partnership with retail chain Kohl’s, Ulta’s brand recognition and existing network of stores still make it a strong competitor in the prestige beauty market.
Ulta is also hoping to expand its moat into the Mexican market beginning next year. That opportunity is currently estimated at about $9.5 billion, a number that will likely continue growing as consumer discretionary spending in Latin America continues to rise.
The Mexican market also presents an opportunity to get away from the mounting pressure from Sephora. 900 of the rival chain’s stores are in Kohl’s locations, but Kohl’s doesn’t currently have a presence in Mexico.
Sephora has just 37 locations in Mexico at the time of this writing. Given Ulta’s experience with rapid retail expansion, it’s quite possible that the chain will gain an advantage over Sephora there.
Ulta’s Growth Is Slowing but Not Reversing
One of the major concerns around Ulta recently has been a slowdown in its growth. Throughout much of the 2010s, Ulta was able to sustain revenue growth rates in excess of 20%.
As the US economy emerged from the 2020-21 era, the company’s revenue growth rates once again spiked into the high teens and low 20s.
As of the most recent quarterly report, revenue growth had slowed to just 3.5%. Even with this slowdown, though, Ulta’s revenue is plateauing at a level far above where it was even 3-5 years ago.
A similar trend can be seen in net income growth. Ulta reported double-digit net income growth through nearly all of the 2010s and saw a gigantic spike subsequent to 2021.
While net income dropped 9.8% in the last reported quarter, Ulta’s profits today are much higher than they were before lockdowns. As of the last reporting period, the company’s trailing 12-month net income was $1.26 billion, compared with $0.71 billion in 2019.
Looking forward, analysts expect Ulta’s earnings per share to keep growing at a rate of about 6.9% annually over the next 3-5 years. Though far from blowout growth, this kind of steady, gradual increase in earnings is the sort of trend that defines many of Buffett’s value stocks.
Ulta’s leading position in the prestige beauty market is also likely to keep it growing well beyond the 5-year horizon. By 2030, the cosmetics market in the United States alone is expected to eclipse $400 billion. Ulta will likely benefit from ongoing growth in this category, especially if it continues to expand into international markets.
Ulta’s Fundamentals Look Fairly Strong
Although growth is slowing, Ulta’s fundamentals still look fairly strong. In its most recent quarterly report, the company detailed net income of $313.1 million on revenues of $2.7 billion. This translates to a net margin of about 11.6%, slightly above the 11.1% the company averaged over its last full fiscal year.
Another strong point for Ulta is its balance sheet. The company has a debt-to-equity ratio of 0 and a current ratio of 1.8, resulting in a very strong financial position from which to pursue further growth initiatives. The company also has a reserve of over $520 million in cash and cash equivalents that it can deploy as needed.
A final fundamental strength of Ulta is its cash flow. In the last full fiscal year, the company reported cash flows of $36.24 per share.
With no long-term debt and a good cash reserve already in place, the cash generated by Ulta’s business operations can readily be reinvested into the company or allocated to share repurchases.
The Stock Was Likely Undervalued
Given Berkshire Hathaway’s longtime connection with value investing, perhaps the best explanation for the Ulta buy is the fact that the stock appeared to be undervalued when Buffett acquired it.
Even after a price increase that occurred when news of Buffett’s interest in the stock broke, Ulta today trades at just 14.7 times forward earnings and 10.4 times cash flows.
Given that the S&P 500 is currently priced at about 21.7 times forward earnings, ULTA shares appear to trade at a substantial discount to the broader market.
The view that ULTA shares are undervalued seems to be shared by the company’s management, as Ulta has pursued a fairly aggressive program of share buybacks over the last several years.
At the peak in 2014 and 2015, there were about 65 million shares of Ulta outstanding. Today, that number has been cut to just 48 million.
In the most recent quarter, the company repurchased about $285 million worth of its own stock. An additional repurchase authorization of $1.8 billion makes it likely that the reduction in outstanding shares will continue to be a defining trend at Ulta for the foreseeable future.
Why Did Buffett Buy Ulta Beauty Stock?
Buffett appears to have bought Ulta Beauty stock because it was trading at a low P/E ratio and had an aggressive share buyback in place to the tune of $285 million last quarter and another $1.8 billon in the future.
Taking all of the above into consideration, Ulta begins to look like a fairly classic Buffett stock pick. The company enjoys a prime position within a growing market, has maintained good fundamental performance and boasts a strong balance sheet.
Paired with attractive pricing multiples that may not accurately reflect the company’s long-term value, Ulta appears to have several of the characteristics Buffett is known to look for when selecting his stocks.
It’s also fairly likely that the Ulta position could be a profitable investment for Berkshire. Today, the median target price for ULTA shares is $500, more than 30% above the most recent trading price of $377.23.
If the company continues to grow as expected over the next several years, Berkshire may very well see very respectable returns from its new stake in Ulta.
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