Warren Buffett’s company, Berkshire Hathaway, recently bought shares of Ulta Beauty for the first time. By June 30, it held over 690,000 shares of the cosmetics retailer, a position worth about $250 million. Buffett often sees value in simple businesses with long-term demand.
Ulta Beauty is a brick-and-mortar retail chain with more than 1,400 locations. The cosmetics industry is not rapidly changing, which adds to the simplicity and predictability of Ulta’s business model. Buffett focuses on the cash that a business produces.
Ulta Beauty has steadily grown its free cash flow over the past decade, generating close to $1 billion annually. It trades at less than 18 times earnings, one of its cheapest levels ever. Companies like Ulta do not need to reinvest excessively, so much of its cash can be returned to shareholders.
Ulta has been actively reducing its outstanding share count and boosting its free cash flow per share. Ulta’s business is easy to understand, stable, and resistant to change. These qualities make it easier to predict its future cash flows.
It trades at a reasonable valuation.
Buffett’s Ulta investment draws attention
This combination of attractive qualities likely drove Buffett’s decision to invest in Ulta Beauty.
In a recent analysis, B. Riley initiated coverage of several beauty stocks. Analyst Anna Glaessgen has given Ulta Beauty a Sell rating with a $300 price target.
Glaessgen cited category deceleration and increased competition as key reasons for the rating. Conversely, e.l.f. Beauty received a Buy rating and a $175 price target from Glaessgen, who praised the company as a “high-quality growth story” with a strong grip on category growth. Ulta Beauty has dropped 34% from its all-time high, but historically, buying large dips in ULTA stock has been profitable.
Despite short-term issues like expected earnings decline and stagnant revenue, the beauty market’s growth should drive future gains. Ulta Beauty is currently undervalued, with modest growth priced in, and possesses key competitive advantages. These include a high return on equity, gross profit margins over 40%, a strong economic moat via its brand power and loyalty program, and a low valuation.
Ulta’s forward non-GAAP P/E ratio of 15.76x is 44.1% lower than its five-year average. The market is pricing in a 2.168% free cash flow per share growth for Ulta Beauty over the next 10 years and then 2.5% per year in perpetuity. Considering that Ulta’s free cash flow has grown at a CAGR of 10.3% over the past five years, this seems like a pessimistic view of the future, suggesting even more potential for growth.
