After reducing his holdings in Apple, Buffett's new direction

Yesterday, Berkshire disclosed its second-quarter holdings, with changes in the top ten heavy positions. In addition to the well-known 49.3% reduction in Apple, it also reduced its holdings in Chevron by 3.5%. It continued to increase its holdings in Occidental Petroleum by 2.93% and increased its holdings in Aon by 4.28%. After reducing its holdings in Apple, Buffett, with nearly $280 billion in hand, established positions in two new companies in the second quarter. One is Ulta Beauty, the largest offline cosmetics company in the United States, with a holding amount of $266 million. The other is HEI Aerospace, with a holding amount of $185 million, mainly engaged in aviation maintenance, aviation materials, and military materials. Both of these are typical long-term high-growth stocks in the United States, with gains of over a hundred times since their listing. According to Whalewisdom's calculations, Buffett's cost of holding HEI Aerospace is approximately 177.5 yuan. As of yesterday's after-hours price, it was 190 yuan, up 3% after hours. Ulta Beauty's cost of holding is approximately 385 yuan. Due to the disclosure of Buffett's purchase, Ulta Beauty surged 13% after hours yesterday, with an after-hours price of 375 yuan. Excluding the surge after hours, Buffett had nearly a 15% loss before, and the stock price had dropped to 320 yuan at one point. The market has expressed considerable confusion about Buffett's establishment of positions in these two companies. On the one hand, Ulta Beauty has fallen by 40% in the past six months, with a pessimistic sales outlook, which is now a point of contention. HEI Aerospace is valued very high, which doesn't seem like Buffett's typical move. These are two different investment styles. What might the stock god see in them?   I. Representative of the lipstick economy, Ulta BeautyUlta Beauty went public in 2007 and is currently the largest cosmetics retailer in the United States, with approximately 1,400 stores in 50 states. The number of members has grown from 6 million in 2007 to 44.2 million in 2023, with member consumption accounting for 95%. In the past 18 years, Ulta has achieved double-digit revenue growth for 17 years, except for a 16.8% revenue decline in 2021. Last year, revenue was $11.2 billion, with a net profit of $1.29 billion. Revenue composition by category: makeup 42%, skincare 23%, hair 19%, perfume 10%, services 4% Briefly introduce the background, Ulta's main competitor is Sephora, with approximately 34 million members globally. Ulta has a stronger presence in the U.S. market. The key to Ulta's success is its membership model. In a downturn environment, Ulta covers a wide price range and has stronger user stickiness compared to Sephora. Ulta's membership cashback mechanism allows members to redeem around $125 for every $2000 spent, with higher-tier members enjoying even greater benefits. Unlike major brand counters, Ulta offers its members discounts of 40-50% on promotional days by acquiring clearance products from major brands, typically with a shelf life of around 1 year. Subsequently, Ulta sells these products to consumers at a lower price, enhancing user stickiness through daily cashback accumulation. Beauty products have high repurchase rates, and a good membership system can serve as a moat. Relying on its long-established membership model, Ulta has a strong long-term cash flow capability. It executes buyback plans with its annual discretionary cash flow, leading Ulta's stock price to rise from $4 at its IPO to a high of $570 in March this year. It is a solid long-term lipstick economy stock that can grow even in economic downturns, supported by substantial buybacks. However, in the past six months, the logic of the lipstick economy has been changing. Luxury goods, cosmetics, and other stock prices have plummeted, with Ulta also dropping 40% from its peak. Interestingly, Warren Buffett chose to establish a position during this downturn. The trigger was in April when Ulta's management noted a slowdown in the global cosmetics and luxury goods market growth, lowering Ulta's full-year revenue growth to 3-4%, with an expected annual revenue of $11.5 billion, more pessimistic than the market's 5% growth expectation. As mentioned earlier, in the past 18 years, Ulta's revenue grew at double-digit rates for 17 years, making this the second consecutive year of non-double-digit growth. According to L'Oreal's guidance in June, the global beauty market's sales growth was revised down from 5% to 4.5%. Some foreign views suggest that L'Oreal's guidance is optimistic, with industry growth possibly only at 4%, and some categories may slow to around 3% next year. The industry outlook is not optimistic, so what did Buffett see in Ulta? After this significant decline, Ulta's valuation dropped to around 12 times PE, the lowest in nearly 3 years Of course, when Buffett bought it, the stock price hadn't dropped that much yet, with an estimated valuation of about 14-15 times PE. So we need to consider two points: first, whether Ulta's moat will be broken? Second, is industry demand a short-term impact or a medium to long-term impact? Looking back over the past 3 years, at least Ulta's moat has remained solid. Although the beauty industry has slowed down in the past 3 years, Ulta mainly operates in the U.S. market, which is not as bad in terms of sales compared to other markets. As for industry demand, the U.S. is mainly affected by high inflation, and with recent inflation coming down, the next step is to start cutting interest rates. Will demand rebound accordingly? It is worth noting thatin March, Ulta announced a $20 billion stock buyback plan, and recently management indicated that as of May, there is still $18 billion remaining in the buyback quota. They may pay dividends within the year and repurchase another $10 billion within the year, accounting for about 6% of the latest market value.**From this perspective, the logic of bottom fishing Ulta is not difficult to understand. Despite the industry's slowing growth, even the worst performance in the future has a growth rate of 5%. In addition,**the company has no interest-bearing debt, with operating cash flow exceeding net profit every year. FY24 operating cash flow/revenue is 13%, and disposable cash flow is used for buybacks + dividends.**The moat has also been tested for over a decade, with valuation dropping to a near 3-year low of 12 times PE. This may be one of the reasons for the God of Stocks to establish a new position, which also aligns with Warren Buffett's investment style. However, another stock, Haikong Aviation, is completely different from Buffett's style.Second, the high PE hundredfold stock: Haikong AviationHaikong Aviation is an aircraft parts manufacturer that went public in 2002 and has risen over a hundredfold since then. The stock price chart is exaggerated, always rising without stopping except for a few weeks of sharp decline during the 2020 pandemic stock market meltdown, unaffected by economic cycles at other times. In 2023, revenue was $2.97 billion, with a net profit of $400 million. The company's gross profit margin has consistently remained above 38%, and operating profit margin has been above 20% for years, which is related to the industry's unique model. Quoting Snowball's "Lightning Koala" introduction,General Electric, Pratt & Whitney, and other major manufacturers need to spend huge sums on developing new equipment, so products that have just entered the market are not profitable and can only make money from subsequent replacements and service markets. This means that the profit margin in the aviation aftermarket is very high. In order to reduce costs, airlines are motivated to purchase some replaceable non-patented parts from third-party suppliers. Haikong Aviation is responsible for the aviation aftermarket third-party parts, imitating original parts with low development costs, cheap prices, and qualified quality, requiring approval and authorization from the FAA. In a downturn in the economic cycle, airlines need to reduce costs more, which gives Haikong Aviation greater opportunities. For example, Haikong's component prices are 20-30% cheaper than Boeing/Airbus OEM parts, with most components priced below $5,000, so many airlines are willing to turn to Haikong. It is worth noting that industry demand is very stable because airplanes do not stop flying or undergo fewer flights for maintenance inspections. These components need regular maintenance regardless of how many times the aircraft has flown, so customer demand is very strong. However, these aviation parts may face competition from peers as they are not protected by patents, requiring speed and quality competition. According to Haikong Aviation, Haikong has delivered 83.52 million components without quality incidents, saving customers $2 billion in procurement costs. The industry has a high barrier to entry due to strict regulation by aviation authorities, resulting in low industry concentration and many merger opportunities. Statistics show that there are more than 2,300 component suppliers active in their respective subfields in the United States. In the past 34 years, Haikong has conducted 98 M&A transactions with $5 billion, with only 2 asset divestitures, achieving an annualized return of 22%. Besides the aftermarket component business, Haikong's second business is defense military components, with many components used in various high-tech weapons of the U.S. Army, Navy, and Air Force, including missiles, drones, satellites, etc., with high technological and political barriers. In addition, due to the continuous increase in U.S. defense spending in recent years, the military business serves as a hedge and protection for Haikong. For example, in 2020, due to the pandemic causing a large number of passenger planes to be grounded, affecting the aftermarket component business, the growth in defense components offset the decline in aircraft component sales. Interestingly, Haikong Aviation employees have made more money on their own stock than they have earned in wages at the company, with over 400 employees having over a million dollars in company stock assets in their U.S. 401K retirement accounts. Returning to why Buffett bought it, it's actually hard to understand. It should be noted that Buffett never buys stocks with very high PEs, or buying Haikong Aviation was not his idea. In terms of P/E ratio, Haikong Aviation's market value is $32.8 billion, and the company may earn $450 million this year, corresponding to a P/E ratio of at least 70 times PE. Due to the company's many M&A cases, amortization expenses have reduced accounting profits. Another valuation method in the market is that the company's annual free cash flow has always been higher than accounting profits. If the profits after adding back amortization expenses are higher, the valuation will be relatively lower. If calculated based on a free cash flow of $600 million for 24 years, the current dynamic valuation of the company's free cash flow is around 54 times. However, even so, it is still not cheap. Conclusion Apart from the expensive valuation, The military business of Hikvision has also attracted considerable market attention.

In a previous article "Trump trade beneficiaries, global arms suppliers", we analyzed the significant increase in military spending by the United States, G7, and NATO countries in recent years, which is a noteworthy signal. The surge in Japanese military stocks raises the question of whether investors are eyeing the future potential of the defense industry