Ulta Beauty (ULTA) is a “Quality Cannibal Stock.” It’s the largest specialty beauty retailer in the United States, known for its wide range of beauty products and services. The company offers more than 25,000 products from more than 600 beauty brands, says CQ, editor of Compounding Quality.

Ulta Beauty has 1,300 stores and is aiming for 1,500-1,700 stores in the long term. Ulta’s competitive advantage is mainly based on its loyalty program ‘Ultamate Rewards’. Roughly 25% of all US women are Ultamate Members and loyalty members account for 95% of the company’s revenue.

The market for beauty products should grow at a CAGR of 5% until 2030 and Ulta Beauty has a market share of 9% in the American beauty product industry. The main risks for the company are that Sephora (part of LVMH) is Ulta’s main competitor, and that Estée Lauder and L’Oréal are two very important suppliers for the company.

Ulta Beauty has a very conservative balance sheet as the company has always expanded nationally without using debt. In addition to this, the company doesn’t need a lot of capital to operate as we estimate that CAPEX/Sales will be equal to 3.6% over the next few years.

Management has great capital allocation skills focusing on organic growth and share repurchases. Its ROIC has averaged 20.6% over the past five years. Ulta Beauty will use 85%-90% of its free cash flow to buy back shares. When it keeps doing this over the next decade, it might buy back up to 50% of its outstanding shares. The company doesn’t pay a dividend.

Ulta Beauty operates at a profit margin of roughly 10% on average and doesn’t use a lot of Stock-Based Compensation to reward management or employees. The company has grown its revenue at a CAGR of 17.6% over the past 15 years.

It’s important to highlight that the strong growth phase is (probably) over for the company. It is estimated that the company will grow its sales at a CAGR of 6% over the next decade. This growth doesn’t seem very attractive at first sight. But when you consider the fact that Ulta Beauty could buy up to 50% of its outstanding shares over the next decade, and its low valuation levels, you can see how investors may end up with very satisfying results.

Ulta Beauty currently trades at one of the cheapest valuation levels the company has traded at over the past decade. A reverse DCF indicates that the company should be able to grow its free cash flow by 6.5% over the next decade to return 10% per year to shareholders. We think this estimate from the market is too conservative.

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