It’s been an awful year for Ulta Beauty (ULTA -0.38%). The cosmetics and fragrances retailer is struggling through the inflationary environment, which is eroding its margins. It got a boost from Warren Buffett when Berkshire Hathaway bought shares in the 2024 second quarter, and then it lost that vote of confidence when Berkshire dumped most of its shares in the third quarter.

Result: Ulta stock is down 29% over the past year at the same time that the S&P 500 is up 22%. Still, let’s see where it could be in one year.

A key player in beauty

Ulta is a major cosmetics, skincare, and haircare retailer that has changed the way customers shop for beauty products. It’s differentiated from other beauty retailers in a number of ways.

The most obvious is that it houses all kinds of brands together under one roof, in contrast with the traditional beauty model, which separates luxury and mass brands. Ulta identified the “beauty enthusiast,” who takes from all price ranges. The model of having everything together doesn’t work for all industries, but Ulta realized that it can work for beauty, and it’s leveraging that wisdom to stock its huge stores with more than 600 brands of all stripes.

It also offers beauty services on top of its products, creating a one-stop shop for the beauty-minded consumer. This model generates higher revenue both because there’s more to spend on and because people who come in for services tend to buy products as well.

This approach has attracted millions of loyal fans who find what they need at Ulta’s beauty megastores. It has 44 million members and growing, and these members are part of a group that drives growth in the industry, accounting for 95% of Ulta’s sales. Ulta estimates that there are 140 million beauty enthusiasts, up from 70 million in 2021, and it’s poised to bring them in as members.

Ulta has 1,437 stand-alone stores and several hundred shop-in-shop stores at Target locations, and it expects to continue opening stores annually. It opened 28 new stores in the third quarter.

Getting ready for a rebound

As you might imagine, Ulta had been reporting strong and steady growth, with high profits and wide margins. But inflation has broken through this solid model. People are cutting back on luxury goods, and if they’re buying discretionary merchandise like cosmetics, they’re switching down to cheaper brands. The good news is that Ulta has those, too, so at least these loyal customers are still coming to Ulta. The bad news is that there isn’t a clear end point in sight for when business might pick up.

In the 2024 fiscal third quarter (ended Nov. 2), sales were up 1.7%, and even comparable sales inched up 0.6% driven by a 0.5% increase in transactions. As expected, the increase implies people are shopping in stores but spending less. That still points to its model working.

Operating margin fell from 13.1% in 2023 to 12.6% in 2024, and this metric has been the market’s main problem with Ulta’s performance. Earnings per share increased from $5.07 to $5.14. Management slightly raised its full-year outlook after the report from a 12.7% to 13% operating margin to 12.9% to 13.1%.

This is a solid industry leader with future expansion potential and strong track record. I see its issues as external headwinds rather than company problems.

Can it happen by next year?

Ulta recently got a new leader in president and COO Kecia Steelman, who will now serve as president and CEO. She’s a company veteran, but she may bring a fresh perspective to the leading role, and that could impact what happens over the next 12 months.

But where Ulta is a year from now depends in part on what’s happening in the economy. If interest rates continue to go down and people go back to spending more, it’s well positioned to rebound. If that doesn’t happen over the next 12 months, Ulta’s business will remain challenged. However, considering its declines, it has a chance to demonstrate year-over-year improvement, and that’s what investors are going to want to see.

The other major factor in Ulta’s stock performance is likely to be its operating margin. It shot up after pandemic lows and has since been trending down.

ULTA Operating Margin (Quarterly) data by YCharts

Ulta is still rewarding investors with share buybacks, and it repurchased $267 million in the third quarter. It expects to buy back $1 billion in shares for the full fiscal year. The stock is also trading at a P/E ratio of only 15. In many ways, it’s the ideal Buffett stock, and it’s not surprising that Berkshire Hathaway is holding onto some of its position.

A year from now, Ulta is likely to be in a better position than it is today, even if the economy remains pressured. Long-term, Ulta has excellent prospects, and it looks like a bargain at the current price.