Small Caps | Feb 17 2020
Growth for Baby Bunting may be more challenging in future but brokers still like the stock as a defensive growth option.
-Fewer benefits in future emanating from closure of baby goods competitors
-Less exposed to coronavirus risk versus other retailers in China
-Gross margin expansion stemming from private labels and exclusive products
By Eva Brocklehurst
Baby Bunting ((BBN)) continues to establish itself at the forefront of the baby goods sector, although brokers mull just how long gross margins can coniine to expand.
Citi expects growth will become more challenging in future, as the company no longer has the direct benefit to sales from the closure of competitor stores. Furthermore, risks, in the short term at least, are elevated from coronavirus.
However, Morgan Stanley notes of strong start to the second half, with comparable sales rebounding to growth of 5.7%. Sales growth in the first six weeks of the second half was up 5.7% and FY20 operating earnings (EBITDA) guidance of $34-37m has been reiterated.
Assuming a similar first:second half skew as occurred in FY19 implies Baby Bunting should meet the bottom end of its operating earnings forecast range. FY20 net profit guidance is $20-22m. This appears achievable to Citi but does not account for any disruption from coronavirus which, based on the broker's feedback from China, has potential to affect sales.
Nevertheless, Baby Bunting is less exposed to this risk compared with other retailers. Additional inventory is expected to be sufficient to cover delays. There is an increased skew to the second half required in order to hit guidance.
An update on the store network plan is expected in April or May. The combination of competitor closures and success in shopping centres signals to Citi an upgrade to the 80-store target is likely. The broker's target price would increase by 15% should the company upgrade the target to 100 stores.
That said, success online, excluding the recent problems with the website, could mean that fewer stores are required over the longer run. The upgrade to the website has not gone as planned, with a major vendor unable to implement the check-out processes that are required to maintain conversion rates and the company has had to reinstate its old site.
Management has acknowledged some cannibalisation from new larger format stores. Morgans highlights the risk of cannibalising same-store sales growth from rolling out further stores, but still believes this is the right strategy given the potential.
While disappointed with the execution issues on the website, nothing changes the broker's view on the quantum and duration of the growth profile.
Margins appear to be on track, which Citi believes is a testament to the strong and stable management. Gross margins expanded to 36.9%, with the company guiding to a full year margin of 37%.
This implies margin expansion is likely to be an ongoing theme in the foreseeable future, stemming from private-label and exclusive product but also a more efficient supply chain.
Private-label/exclusive products grew to 35.5% of sales in the first half. Online sales growth was 10.5%. One of the main risks the broker envisages regarding continually expanding gross margins is that suppliers also want to grow profitably.
Should supplier profitability reduce they may increasingly look towards other sales channels. Moreover, the wider the company's margins become, the greater the likelihood that competition may enter the category.
Macquarie considers this stock a defensive growth option, with any share price weakness typically representing good buying opportunities. Baby Bunting is also a key pick for Morgans, which remains attracted to the significant long-dated growth profile.
The main risks centre on consumer sentiment, Amazon, a falling Australian dollar and failure to secure store sites. FNArena's database has four Buy ratings. The consensus target is $3.92, signalling 8.9% upside to the last share price.
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