A tiny write up on Ulta Beauty (ULTA)

This post is about Ulta Beauty. It isn’t as undervalued as i would like and currently everyone is very skeptical about this company, which means it is a good watchlist stock because i think it is going to do well business-wise and prove its critics wrong. I owned this stock previously, sold at a slight profit. I haven’t decided whether to go back in again, but i am thinking about it.

The background

In the world of cosmetics and makeup, a shop either sells mass beauty or prestige products. Ulta Beauty does both. Which means the level of competitive is supper intense, on the low end their biggest competitor are Walmart and Amazon, on the high end, their no.1 enemy is Sephora. Before Covid, the business was growing around 23-26+% earnings a year with a 97% consistency from Jan 2006 to Jan 2020. The business got a bump up after Covid and people got back to work, however, this did not last. LVMH’s Sephora was working with Kohl with a store within a store concept. And quickly Sephora grew to 1,100 locations without having to worry about building new stores. ULTA fought back by rising prices, customers rebelled and Same store sales fell.

Around this time in early 2024, Berkshire Hathaway (likely Todd Combs) tipped its toes in ULTA and bought a miniscule position at an average price of $385. This was not a forever stock and the 1.4% stake in ULTA was sold after 1 or 2 quarters.

Things did not get better and ULTA lost market share to Sephora. The CEO was changed and a long time executive took over in Jan 2025. She terminated an agreement with Target to rollout a  copycat version of “Sephora at Kohl’s” because of Target’s level of shrinkage (read Theft). Instead she went on the offensive and opened new stores in Mexico, as well as bought a luxury chain in UK Space NK. Recent activities include opening a storefront on Tiktok and focus on wellness products.

Moat

They have a moat, i just don’t know what it is. But its there, how else can you explain a big gap between return of capital over the costs since 2007 IPO. Maybe they caught a tailwind where young women wanted face to face advice to try products, or maybe on-screen tech isn’t there yet to virtualise the face with products yet. Morningstar says their 46+m membership loyalty programme is a moat.

“As evidence of its competitive edge, over the past five years, Ulta has achieved average annual gross and adjusted operating margins of 39% and 15%, respectively. For comparison, US department stores typically report operating margins in the midsingle digits. Moreover, Ulta's margins have expanded as the firm has grown. Prior to 2010, the company reported gross and operating margins of about 30% and 5%, respectively. Further, Ulta’s adjusted returns on invested capital including goodwill have consistently been above our 9% weighted average cost of capital estimate at an annual average of 22% over the past 10 years. Over the next 10 years, we estimate its ROICs will average about 22% as well.”

Current Pessimism

They beat revenue, earnings and raised EPS guidance. Nevertheless Wall Street isn’t convinced at at, Barron’s which has ULTA as a 2025/2026 recommendation has this to say a couple of days ago:

Beauty is subjective, but it’s hard to paint a pretty picture about Ulta Beauty stock after its recent quarter.

Ulta has been a long-term winner, more than doubling its shares since the pandemic through its highs in February. Unfortunately, our timing hasn’t captured any of this as the stock is down more than 30% since our pick and about 13% since we followed up in March.

Ulta’s recently completed first quarter had a number of good points, including upbeat sales and same-store sales, an increase in average purchases and purchase prices, and a 4% increase in loyalty members. The company was able to maintain its guidance despite ongoing upheaval with the consumer.

That wasn’t good enough for the Street though. Investors are concerned that guidance implies earnings per share growth and that improved margins, based in part on reduced ‘shrink,’ or industry-speak for theft, isn’t sustainable.

“As expressed directly on the earnings call in the form of several questions about implied deceleration and gross margin softness, there is clear anxiety that capacity to maintain or take share increasingly requires steeper investment that puts earnings at greater risk,” William Blair analyst Dylan Carden wrote in a note.

Beauty has always been a very competitive industry. With more products going viral on social media, it can be difficult for legacy and bricks-and-mortar players to keep up. Moreover, while prestige products had a strong showing—more evidence that the wealthy are still spending—there are concerns about how regular consumers will hold up in the face of ongoing inflation.

It’s worth noting that Ulta’s recent launch on TikTok Shop is attracting a new, younger consumer. Management expects this to bring more people into its stores and notes that it isn’t seeing evidence of customers trading down, despite the spike in energy prices.

Nonetheless, if the best of EPS momentum is behind the stock and the company doesn’t provide evidence of more enduring factors pushing up margins—and technicals are against it—the stock will likely continue to suffer from worries that shoppers have too many other options and not enough spare cash.

When I asked Lucy Diamonds, she added two additional points, inventory is growting faster than sales, and this is a red flag. The other point is that the CEO is new and analysts are quite unforgiving and treating the company as a Show-Me stock. Eg. Why would the company be investing in the UK and Mexico when it should be defending against the Sephora barbarian at the gates ?

I ask Lucy Diamonds to create some metric charts for me based on Capex/D&A, Inventory/Sales, Same Store Sales components. etc.

When i looked at it, it tells me that Sephora and ULTA are behaving rationally and are growing by taking market share from traditional departmental stores. ULTA's latest Same Store sales show that the 5+% increase came about by 1.6% increase by foot traffice and 3.7% increase in receipt.

As comparison, this is what morningstar had to say about Sephora at Kohl’s

Ulta's results contrast sharply with those of no-moat Kohl's Sephora stores, which experienced a low-single-digit sales decline in the first quarter. Ulta has shown that it can continue to take share from department stores with prestige beauty offerings.

Note the LVMH is secretive about their nos. These comments from Morningstar came from Kohl's recent earnings call because they had to explain a lag in their quarterly performance.

This tells me that Ulta Beauty knows how to compete, because their DNA has always been about competing in the  Mass beauty and Presige beauty segment.

If you want to read about Lucy’s excellent analysis of the metric chart, i will leave the links in the comments.

Valuation

I use a discount rate of 9% and a terminal growth rate of 3%, with a 5 year duration of earnings growth of 10% due to the competitive intensity, my fair value comes to around $556 to $616.

Morningstar and CFRA are less charitable and have given ULTA a fair value price of $510 and $526.

Next Steps:

If the  price goes near to Berkshire’s buy price , i will buy a position again.