It’s Not Just Warren Buffett; We Also Think Ulta Beauty Is a Buy

Berkshire Hathaway BRK.A/BRK.B disclosed that it has bought 690,106 shares of Ulta Beauty ULTA for an estimated $315 million. Before the news, Ulta’s stock was down nearly 33% in 2024. Here’s Morningstar’s take on the outlook for Ulta, the largest specialized beauty retailer in the United States.

Key Morningstar Metrics for Ulta Beauty

• Fair Value Estimate: $405.00
• Morningstar Rating: 4 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

What We Think of Ulta Beauty’s Stock

• Ulta has felt some competitive pressure, especially in prestige makeup. The aggressive build-out of Sephora stores within Kohl’s stores has drawn some sales from the firm. An increase in the number of beauty products offered on Amazon AMZN is also probably having some effect.
• Ulta’s same-store sales growth numbers have weakened from the strong levels of the past. The company lowered its 2024 guidance when reporting earnings in May.
• Despite the challenges, Ulta has a steadfast customer base, with over 43 million members in its loyalty program. The company has taken share from department and drug stores for years, and we think its partnership with Target TGT will make it even stronger.
• Ulta remains the launching ground for many new beauty brands and products. It also benefits from having off-mall stores and offering products at all price points.
• Ulta’s store growth in the US is slowing, but it has a deal to expand into Mexico and will eventually consider other international growth opportunities. The firm will discuss plans during an analyst day in October.
• We have often rated Ulta’s stock as overvalued, but it’s more attractive after its price drop. Our fair value estimate is $405 per share. Our earnings per share estimate for 2024 is $25.73, so it’s trading at a price/earnings ratio of about 14. The stock has traded at higher valuations in the past.

Fair Value Estimate for Ulta Stock

With its 4-star rating, we believe Ulta’s stock is undervalued compared with our long-term fair value estimate of $405 per share. For 2024, we forecast 2.4% same-store sales growth (down from 4.4%), a 13.9% operating margin (down from 14.3%), and earnings per share of $25.73 (down from $27.11). Our fair value estimate implies a fiscal 2024 price/earnings ratio of about 16 and an enterprise value/EBITDA ratio of about 10.

We estimate Ulta will achieve 5% compound average sales growth over the next 10 years, well below its 16% average annual sales growth over the past decade. We forecast 4% yearly same-store sales growth in the long term. Past results were aided by many new stores that matured over time, bolstered marketing, an improved loyalty program, and brand additions. Ulta currently has many mature stores, and we expect new locations in existing markets will reduce sales at those stores.

Read more about Ulta Beauty’s fair value estimate.

Economic Moat Rating

We assign Ulta a narrow moat due to the strength of its brand intangibles. It’s the largest specialty beauty retailer in the US, with about 1,400 stores and 2023 sales above $11 billion. We believe it carries more products and brands in the major beauty categories of makeup, hair care, skincare, fragrance, bath, and accessories than any other US specialty beauty retailer. As evidence of the firm’s competitive edge, its adjusted return on invested capital including goodwill has consistently been over our 9% estimated weighted average cost of capital. We estimate Ulta’s adjusted ROIC including goodwill will average 31% over the next decade.

Read more about Ulta Beauty’s economic moat.

Financial Strength

Ulta is in excellent financial health. The firm borrowed $800 million on its $1 billion revolving credit facility in 2020 but paid all of it back within a few months. Apart from short-term loans for liquidity, we do not think Ulta will need to borrow again in the foreseeable future. Although affected by inflation, the firm has conserved cash by reducing operating expenses and slowing store openings. It closed April 2024 with $525 million in cash, and we estimate it will generate about $1.1 billion in free cash flow this year.

Ulta is the rare retailer that expanded nationally without debt, financing its expansion with cash flow and using tenant improvement allowances offered by landlords. In exchange, the company was often locked into above-market rents. We expect it will negotiate lower rents as leases expire and continue to open new stores without debt.

Read more about Ulta Beauty’s financial strength.

Risk and Uncertainty

Our Uncertainty Rating for Ulta is Medium. We think the firm’s push into prestige beauty, its large e-commerce presence (about 20% of sales), its many loyalty program members, and its partnership with Target make it less risky than many other retailers of consumer products.

Even so, Ulta competes with drugstores, mass merchandisers, department stores, e-commerce, and many others. Direct competitor Sephora has expanded rapidly in suburban areas by opening shops within Kohl’s locations, while Amazon continues to increase its partnerships with leading beauty brands.

Ulta is also exposed to changes in the retail landscape in the US, currently the source of 100% of its revenue. Many physical stores and shopping centers are experiencing declining traffic due to online competition and market saturation. Most Ulta stores are in suburban strip centers. While possibly healthier than many indoor malls, some centers are in decline. However, we believe Ulta’s relatively newer store footprint and lease expirations in the next 10 years should let it move some stores.

Read more about Ulta Beauty’s risk and uncertainty.

ULTA Bulls Say

• As the largest specialty beauty retailer in the US, Ulta has access to leading brands and exclusive products. Its merchandising encourages frequent store visitation and draws shoppers from department stores.
• Ulta’s loyalty program of more than 40 million active members is getting a boost from its expanding Target shop-in-shops. Ulta can use consumer data to improve its marketing, merchandising, and e-commerce.
• Ulta benefits from rising consumer interest in beauty and wellness and the proliferation of innovative products with high price points.

ULTA Bears Say

• Beauty products are available through many retail channels, putting Ulta in competition with the largest retailers in the US. Ulta has been negatively affected by Sephora’s partnership with Kohl’s and Amazon’s big push into beauty.
• Ulta has no control over consumer spending on beauty or product releases from major producers, but these factors can affect its sales.
• Ulta’s sales growth has slowed from peak levels as it has become much larger and opportunities for new US stores have diminished.

This article was compiled by Leona Murray.