Why Did Buffett’s Berkshire Purchase Ulta Beauty?

In the latest 13F filing, which shows major fund managers’ investment disclosure, it was revealed that Warren Buffett’s Berkshire Hathaway bought 690,000 shares of Ulta Beauty Inc (ticker: Ulta).

That works out to be a roughly $260 million position.

Whenever there is a new holding in Berkshire, many would speculate their reasons for the purchase.

This should be a purchase by one of Buffett’s lieutenants because likely Buffett will mess with those purchases that are billions and above.

If I were to guess, Ulta is an interesting proposition because:

1. There is a unique element regarding their business that allows them to continue to do as well.
2. Ulta historically has frequent stock buyback programs. Buffett and gang likes that.
3. Ulta got cheap enough.

Here are some of my consolidated findings which might interest you.

Ulta’s History of Share Buybacks.

In March this year, Ulta announced a $2 billion share buyback program. As of 4th of May, they still have $1.8 billion remaining. Based on the share price of $377, they could buyback 4.8 million shares if Ulta’s share price remains in its current position.

Here’s Ulta outstanding shares history:

	Outstanding Shares (Mil)
2010	59
2011	61
2012	63
2013	64
2014	64
2015	65
2016	64
2017	63
2018	62
2019	60
2020	58
2021	57
2022	55
2023	52

Ulta is currently in net cash, so they are not taking on debt in order to buy back their shares. Declaring a buyback program may be an inference that the company is confident of its cash flow that they would choose to reward shareholders.

This chart above shows the percentage of Ulta’s stock the company bought back in the short span.

The more shares repurchased, the greater the share of net income shared among shareholders.

The Range of Price that Berkshire Possibly Bought Ulta At

Berkshire’s filing is for the second quarter, which means that the price they paid for their Ulta stake should be between $375 and $469. Ulta’s current share price is at the lowest of their possible purchase price.

What Ulta is Struggling With, Which May Cause the Share Price to be Like This.

On April 2, Ulta Beauty CEO Dave Kimbell warned investors of “a slowdown in the total category across price points and segments.”

Ulta’s comparable sales growth has slowed to 1.6% for Q1 2024. Analysts are expecting their 2025 EPS growth to be flat to negative. The bane of a growth stock is when the world thinks they would never grow at the same pace again.

Retail, such as Ulta, is largely fixed cost, and the worry here is that when growth slows, we get the negative operating leverage effect that makes us like some of these companies in the first place. Ulta lowered its operating margin outlook for FY24 because it thought its revenue growth was below expectations.

Investors may also be concerned about how Ulta’s growth would look like with fewer store openings. In Ulta’s 2022 Analyst Day, their store maturation target is 1,500 to 1,700 stores. Ulta will hit 1,400 stores soon. The company typically open around 80 stores per year over the last 10 years but in 2023, they open only 30 new stores.

Ulta’s shares have also been under pressure this year, partly due to new competitive dynamics with rival Sephora, which has opened up about 1,000 “store within a store” concepts at Kohl’s Corp. (KSS) locations.

This weighed on Ulta’s market-share momentum in the prestige category. The good news is that Ulta is still picking up market share in the “mass” category.

What Most are Underestimating about Ulta.

William Blair Analyst Dylan Carden feels little overlap between Sephora and Kohl’s customer base, making him wonder how this partnership will work out. He feels that Ulta is in a much more competitive position than a Sephora located within a Kohl’s, since it is not clear whether a department store like Kohl’s will even be around in five years.

D.A Davidson’s analyst Michael Baker says Ulta is in a strong market with rational competitive dynamics, and its executives have been known to be good stewards of capital.

Ulta’s omnichannel strategy, which combines products, services and experience, offers something that other startups or firms with more capital such as Amazon find it difficult to replicate.

They have an opportunity for more growth if their international strategy such as their planned entry into Mexico in 2025 worked out.

Despite being bucketed into the consumer discretionary category, the beauty industry has historically shown resilience during downturns. There is a thing called the “lipstick effect”, which states that when facing an economic crisis, consumers will be more willing to buy less costly luxury goods. Instead of buying expensive purses and fur coats, for example, people will buy expensive cosmetics like lipsticks.

Ulta through the Quality and Value Lens.

Common quality measurements are the ranking of a company’s return on equity, consistency in earnings and the degree of debt over time. I would tend to prefer to reflect upon the return on invested capital (ROIC) instead of ROE because ROE can be seriously boosted if a business brings on a lot of debt. A long history of high ROIC shows that the business has some magic juice that allows them a high return per unit of the invested capital (which is debts and equity minus cash usually).

Ulta’s Last 12 Months Diluted EPS: $6.47 + $5.07 +$6.02 + $6.88 = $24.44

Based on the current share price of $377, Ulta currently trades at a historical PE of 15.4 times.

The following table shows Ulta’s ROIC, debt level, earnings per share and growth, and valuation from 2010 to 2023:

	ROIC (%)	Net Debt to Capital (%)	Diluted EPS	EPS Growth	Avg PE Ratio (Last 12M E)
2010	13.5%	50%	$0.66		18
2011	21.2%	252%	$1.16	76%	22
2012	25.2%	382%	$1.90	64%	30
2013	25.9%	1395%	$2.68	41%	34
2014	23.2%	Net Cash	$3.15	18%	32
2015	22.9%	Net Cash	$3.98	26%	26
2016	23.8%	Net Cash	$4.98	25%	32
2017	27.5%	Net Cash	$6.52	31%	35
2018	33.6%	Net Cash	$8.96	37%	28
2019	36.5%	Net Cash	$10.94	22%	23
2020	25.0%	Net Cash	$12.15	11%	24
2021	7.1%	Net Cash	$3.11	-74%	75
2022	26.8%	Net Cash	$17.98	478%	20
2023	33.9%	Net Cash	$24.01	34%	17

Ulta looks more like a non-profitable company if I judge its share price performance. A review of how they have been operating for the 13 years tell a very different story. Except for the Covid period, Ulta’s ROIC is consistently high.

Some investors may be turn off by Ulta’s low and volatile net profit margins but I think the true reflection is whether they can turn over high ROIC and do it over time. You can have low margins but consistently increase your volume.

Ulta is in a net cash position nowadays and except for 2021, they have pretty good EPS (probably help partly by the share buyback).

Finally, Ulta’s average PE from 2010 to 2023: 30 times.

Ulta currently trades at almost half its average historical PE.

My Take

The challenge is to discern whether the managers in Berkshire determine that Ulta is a special situation or a misunderstood firm that is currently experiencing challenges with a fixable problem.

I think it is a latter, and valuation has become attractive.

If Ulta’s best growth years are behind them, then the current valuation is not demanding. Somehow their buyback program makes me think that they generate much cash flow that they cannot deploy fast enough.

You can adjust the 15 times PE down due to the smaller outstanding shares. Even with the slow down, investors may not need Ulta to go back to the 30 times PE to benefit. Even a move to 20 times PE is a 30% gain in share price.

If Mr Market has misunderstood how long their growth will be down by, then Ulta is an even more attractive proposition. That is basically a double in share price.

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