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Why unloved cosmetics retailer Ulta Beauty is a buy

Ulta Beauty (ULTA:NASDAQ) $391.70
Market cap: $18.5 billion
A 20% year-to-date share price drop at Ulta Beauty (ULTA:NASDAQ), America’s biggest specialist beauty retailer, presents an attractive buying opportunity for growth and value seekers alike. Warren Buffett’s Berkshire Hathaway (BRK:B:NYSE) evidently sees value in the name, having recently snapped up a stake in the Illinois-headquartered make-up, haircare, skincare and fragrance products purveyor which has lately suffered from intensifying competition and cooling consumer demand, with same-store sales growth weakening as a result.
However, in common with the likes of Estee Lauder (EL:NYSE), L’Oreal (OR:EPA), elf Beauty (ELF:NYSE) and Warpaint London (W7L:AIM), Ulta operates in a cosmetics market that has demonstrated resilience through economic cycles, often referred to as ‘the lipstick effect’. In addition, this cashed-up retail cosmetics chain benefits from a loyal customer base and its overseas growth potential doesn’t appear to be priced in, with Ulta’s shares looking cheap relative to history with scope to re-rate if the company can rejuvenate its growth rates.
BEAUTIFUL POSSIBILITIES
Ulta Beauty is the largest beauty retailer in the US, selling both mass and prestige cosmetics, fragrances, skin care and hair care products, as well as offering salon services, through some 1,411 brick and mortar stores and online via ulta.com. Sales topped $11.2 billion in the year to January 2024, an impressive jump from the $7.4 billion of revenue notched up in pre-pandemic 2019.
The $18.5 billion cap benefits from access to leading brands and exclusive products, while its best-in-class merchandising encourages frequent store visits and draws shoppers from department stores. Stockopedia data shows Ulta Beauty’s ROCE (return on capital employed), a key gauge of profitability, exceeded 40% in the last three financial years to January, while Morningstar estimates the company’s adjusted ROIC (return on invested capital) including goodwill will average out at a healthy 31% over the next decade.
Recent share price weakness reflects CEO Dave Kimbell’s warning of softening beauty demand at an investor conference back in April followed up by disappointing second quarter results on 29 August, when Ulta delivered its first EPS (earnings per share) miss since May 2020. Second quarter same-store sales fell 1.2%, well below the 1.4% growth Wall Street was looking for as the company lapped tough prior year comparatives, and Ulta also cut its full year sales and EPS guidance.
Encouragingly for shareholders, including Buffett and Berkshire, Kimbell insisted he was ‘clear about the factors that adversely impacted our store performance’ and insisted Ulta Beauty has ‘actions underway to address the trends. We are focused on driving stronger sales and traffic and continuing to exercise financial discipline.’
Reassuringly, the company is in rude financial health, having closed the quarter with cash and cash equivalents of $414 million, giving it the firepower for future expansion and additional earnings enhancing share buybacks should share price weakness persist.
ATTRACTIVE VALUATION
Morningstar points out that Ulta Beauty has felt some competitive pressure, especially in prestige makeup, noting that ‘direct competitor Sephora has expanded rapidly in suburban areas by opening shops within Kohl’s (KSS:NYSE) locations, while Amazon (AMZN:NASDAQ) continues to increase its partnerships with leading beauty brands’.
That said, Ulta has been taking market share from department and drug stores for years, and Morningstar thinks its partnership with Target (TGT:NYSE) will make it even stronger. And while US sales growth has slowed from peak levels as Ulta Beauty has become much larger and opportunities for new stores across the pond have diminished, the company has a deal to expand into Mexico and will consider other international growth opportunities in time. In fact, Ulta is expected to outline its international growth plans during an analyst day in October, which could act as a catalyst for a share price rebound.
For the year to January 2025, Stockopedia shows Ulta’s net profits are forecast to fall from $1.29 billion to $1.11 billion before rising to $1.15 billion in full year 2026, driving an uptick in EPS from $23.2 to $24.9. Based on those estimates, Ulta’s shares are trading on a prospective PE (price to earnings) ratio of 16.9 for full year 2025 falling to 15.7 on 2026 estimates. That is a massive discount to the stock’s own recent history – the PE multiple peaked at 90 times in 2021 – which should entice contrarian investors prepared to show some patience.
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Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
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