Small Caps | Aug 19 2019
Favourable industry restructuring has allowed Baby Bunting to become the dominant player in the baby goods segment and brokers expect strong earnings growth over the next several years.
-Gross margin upside and operating expenditure leverage envisaged
-Few in the industry have the capability to compete effectively
-Acquisition of car-seat fitting business considered strategically sound
By Eva Brocklehurst
Baby Bunting's ((BBN)) growth spurt shows no sign of slowing, as its market dominance is becoming entrenched in a relatively defensive baby goods sector. The industry structure is favourable, with the number of players having contracted by around 30% in recent years.
The company beat broker estimates in FY19 and raised its guidance for FY20 operating earnings (EBITDA) to $34-37m, expecting to sustain mid single-digit comparable growth rates. Gross margins are expected to exceed 36%. Citi calculates an FY20 price/earnings ratio of 17x is undemanding considering the growth that is forecast.
Morgans believes strong top-line growth will continue over several years, as the footprint expands and the company continues to take market share. This will convert at a much higher operating earnings rate, given gross margin upside and operating expenditure leverage.
Gross margins have been assisted by range improvements, increased direct imports and less industry discounting. Macquarie agrees the exit trends from the second half indicate momentum will continue into FY20. The broker observes, while the company is investing ahead of the curve, there should be operating leverage in FY20 as the maturing of FY18/19 store openings supports growth.
Macquarie considers the stock a core small retail holding and valuation undemanding in a relatively defensive category. The clean inventory position as of June was in line with store growth and resulted in strong cash conversion. The penetration target of private label and exclusive products, ultimately to 50%, is strategically important in differentiating the business from competitors, in the broker's view.
Around $20m will be invested over the next two years to improve the digital offering, loyalty, customer service and brand and from this Morgan Stanley assesses that few in the industry have the capability and access to capital to compete effectively. Digital sales penetration did slow as the offering was re-jigged, but this should provide benefits in FY20, the broker adds.
Morgan Stanley envisages FX volatility will widen the company's cost advantage versus peers, as 90% of stock is bought in Australian dollars and suppliers must provide three-months notice of price changes, which are subject to negotiation.
The expansion into ancillary services has kicked off with the acquisition of car-seat businesses in the fourth quarter. While the earnings impact is immaterial at this point, Macquarie believes this is a positive strategic step to build customer loyalty and engagement. Citi agrees the acquisitions are strategically sound and could help defend against pure-play online competition and less-nimble discount department stores.
This is one of the new growth strategies which have emerged from the results, the broker notes. The acquisition of the four car-seat fitting companies, which were previously run by partners, will allow Baby Bunting to provide standardised car seat fitting services, which other retailers do not offer.
The installers will be able to make add-on sales during the 30-minute fitting time. The company also plans to expand its hiring services, the development currently underway in Queensland and South Australia. However, Citi assesses a risk this could cannibalise existing sales, particularly when it comes to long-term hiring.
The new format Chadstone Mall store, Victoria, has performed well and the company is targeting further expansion of this format. Chadstone is the company's highest volume store and has significant penetration in high-margin categories. However, the fit-out requires a larger investment versus large-format retail stores.
Citi notes Baby Bunting entered the Chadstone and Bankstown, NSW, catchments following the closure of Toys "R" Us/Babies "R" Us. Doncaster, Victoria, is being targeted for opening in October.
Another prong to the company's strategy is the additional stores being rolled out. Baby Bunting will review its target of 80 stores over the next few months, to incorporate the success of its shopping centre format as well as survey recent store closures by competitors. Morgan Stanley believes few retailers offer the roll-out potential of the company as well as such dominance of the category.
While there could be upside to the long-term target of 80 stores, over time Citi envisages stores may also close, should online growth negate the need for a physical footprint in some areas. The broker points out Mothercare, a UK-based baby goods retailer, has reduced its footprint by -51% since FY16 while increasing online sales and re-positioning stores.
FNArena's database shows four from four Buy ratings with a consensus target of $3.17 that suggests 14.4% upside to the last share price. The dividend yield on FY20 and FY21 forecasts is 4.4% and 5.3% respectively.
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