Baby Bunting Market Share Accelerates In FY19

This story features BABY BUNTING GROUP LIMITED. For more info SHARE ANALYSIS: BBN

Instead of the weak trading update brokers feared, Baby Bunting reported strong growth in sales for the first six weeks of FY19 and the share price took off.

-Earnings growing faster than envisaged previously
-Digital transformation and customer engagement should underpin long-term value
-Management confident the impact of competitor consolidation has passed
 

By Eva Brocklehurst

After several indications that Baby Bunting ((BBN)) may be affected by competitor discounting as the industry is rationalised, FY18 results surprised brokers in a positive way. Instead of a weak trading update the company's report for the start of FY19 was quite the opposite. Sales in the first six weeks were up 9.8%. Brokers also highlight the improvement in the company's competitive position.

The share price rallied sharply and Morgan Stanley suggests the earnings profile is following the trajectory envisaged, just faster and more pronounced. The broker's sales estimates for FY19-20 are raised by 5-6%.

Conservatively extrapolating the early stages of a recovery, Morgan Stanley envisages scope for a longer upgrade cycle. While not the cause of this knee-jerk reaction in the share price, the company's digital transformation, with online sales up 63%, and the deeper customer engagement, should underpin long-term value, in the broker's opinion.

Competitor rationalisation was at the core of the FY18 result as inventories were wound down, reflected in weak same-store sales growth, -0.2%, and a contraction in margin of -100 basis points. Still, trends in the second half improved and this was evident to Macquarie in both sales and margin. Management appears confident the impact of competitor consolidation has passed.

Four major competitors have bowed out of the market over the last year or so. FY19 EBITDA (operating earnings) guidance is $24-27m, supported by six new stores and margins over 34%. The company has maintained its long-term operating earnings margin target of 10%.

Morgans believes earnings risk lies to the upside given FY19/20 margin forecasts are still below FY17. The broker considers the sales result a reflection that stock has been run down in anticipation of an exit by competitors from the market and as suppliers exercised caution in relation to trading terms. A more reduced cross-over of product also played a part in limiting the impact on Baby Bunting.

The stock does not appear cheap after the share price reaction on an FY19 PE basis but the broker suggests the premium that is now entrenched can justifiably be credited to the start of a multi-year earnings recovery.

Market Share

FY18 results were no worse than feared and, being overshadowed by a strong start to FY19, Morgans believes the market share opportunity is starting to come through sooner than expected. The company has provided some indications regarding the opportunity and market share created by the exit of its four largest competitors in FY18, signalled at around $138m or 45% of FY18 revenue.

Morgans estimates, taking a more conservative approach, that this opportunity could be $45-50m in the medium term. Combine this with a strong roll-out of stores and multi-year growth should occur at well above the sector average.

Citi reiterates a Buy rating, given that the structural changes in the industry are translating into increased market share and bargaining power for Baby Bunting. Attention for earnings upgrades are envisaged over FY19. The mid point of guidance is implying 11% more in earnings relative to FY17, despite the fact the Baby Bunting now has 28% more stores on average, and its four largest competitors have closed down.

Amazon

Macquarie had anticipated an incremental improvement in operating conditions, but acknowledges current trading was even better than expected and impact of competitor rationalisation was at the core of the result. The broker suggests the valuation appears to now reflect market positioning for further consensus upgrades.

While there is upside, the broker still believes the outlook carries execution risk and requires a supportive consumer environment. Moreover, with Prime recently installed, the offering by Amazon is likely to evolve quickly, the broker suggests.

In this regard, Citi still expects market share gains to more than offset any potential loss of sales to Amazon over the next 12 months. The broker expects the risk to intensify over the medium term as Amazon builds out its range which typically has sharper pricing than other retailers. Further, the broker is unconvinced that Baby Bunting's exclusive products are different enough to create a sustainable barrier to competition.

FNArena's database shows three Buy ratings and one Hold. The consensus target is $2.65, suggesting 9.2% upside to the last share price. This compares with $1.59 ahead of the results. Targets range from $2.25 (Macquarie) to $3.00 (Morgan Stanley).

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