Small Caps | Aug 24 2020
The Sukin brand sustained robust domestic earnings in FY20 although, in order to generate sustained growth, BWX is targeting a greater international profile.
-Improved gross profit margins, led by Sukin
-Given investment, international now needs to contribute substantially
-Are international brands diluting the Sukin growth trajectory?
By Eva Brocklehurst
Strong results from the Sukin brand and an expanded growth profile have led brokers to applaud both the improved quality of earnings and the competence of new management at BWX Ltd ((BWX)).
Guidance for at least 10% revenue and operating earnings growth in FY21 is maintained but Moelis suspects management is being conservative and this forecast is likely to be a base line. Sukin retains a long growth path both domestically and offshore and, in the medium term, the broker anticipates around $100m per annum in Australasian revenue is achievable.
Growth is likely from a 10% price increase, expanded range in Coles supermarkets ((COL)) and the general trend favouring sustainable and ethical products. Despite the pandemic, FY20 operating cash flow of $28m led to significantly lower net debt. Gross profit margins improved to 58%, supported by Sukin which is the highest-margin brand.
However, drivers going forward differ materially from when the company's budget was originally set and this frames Shaw and Partners' recommendations, as BWX is investing in a material international expansion for Sukin and Andalou/Mineral Fusion.
The broker calculates to generate accretion over the longer term requires the international channel to contribute substantially, in the context of an Australian pharmacy business that is maturing or in reverse and as the grocery channel is delivering the majority of the performance improvement.
While acknowledging results have become more sustainable over the last 18 months and Sukin remains the engine of growth, with revenue up 55% in FY20, Shaw and Partners believes there is now a greater level of execution risk derived from the international roll-out.
European expansion is well underway and the company is targeting $30-50m in revenue by FY23. Sukin is already sold in the Boots (pharmacy) and Holland & Barrett (healthcare) chains and the UK is likely to be the initial focus. Citi notes revenue is also expected to be substantial from direct-to-consumer channels such as Amazon.
The broker considers the potential distribution gains in UK/Europe as a counterweight to US retail softness and uncertainty. Success in the US will depend on the company being able to build its brand in a very competitive market and this may be difficult during the pandemic. However, the upside for the longer term in that market is very substantial.
Moelis is disappointed by the performance of Andalou, despite the expansion of the ranges in Chemist Warehouse, although trading conditions for the brand in the US are acknowledged to be difficult because of the pandemic. Canaccord Genuity considers Andalou could sustain even higher gross margins if part of the manufacturing is brought in-house.
The industry median gross margin is around 63% and companies that control their own manufacturing of higher-priced skincare often generate more than 70%, or in some cases 80% gross margins.
Meanwhile, a strong recovery in Mineral Fusion pleased Moelis although growth was weaker than expected. Both brands have stabilised with new management although growth will require expansion into mass markets, the broker adds.
Shaw and Partners also notes sales for these two brands have been disrupted and constant currency growth was relatively flat in the second half. Hence, these international brands are diluting the growth trajectory of Sukin.
As a panacea, the broker envisages either the sale of Andalou and Mineral Fusion or a sale and leaseback of manufacturing could help conserve expenditure. The third option is to streamline costs and consolidate manufacturing in Australia.
This should enable BWX to generate excess capital. To justify the current multiple in an uncertain environment, and noting further capital expenditure is on the horizon, Shaw and Partners retains a Hold rating with a $4.32 target.
In contrast, Moelis has a Buy rating and $5.07 target and Bell Potter upgrades to Buy from Hold with a target of $5.05. The latter highlights the company's strategy is unfolding successfully and legacy issues have largely been put to rest.
Moreover, progress has occurred across several strategic areas including distribution expansion in North America, Asia-Pacific and Europe. Prices per kilogram have also increased across the Sukin and Andalou brands.
Following the recent capital raising the company has excess liquidity – Bell Potter calculates $38.4m – so further growth opportunities can be explored in the natural product category.
The broker is increasingly confident in the longer-term outlook and expects BWX can deliver growth ahead of current guidance, albeit skewed to the second half. Upgrades to estimates for FY21 and FY22 and a reduction in depreciation & amortisation assumptions lead to an upgrade to valuation and hence the upgrade in rating.
Citi agrees the growth outlook is skewed towards the second half, because of the timing of distribution gains, range reviews and the challenging US retail conditions, retaining a Buy rating and $5.05 target.
Canaccord Genuity is not particularly concerned about valuation at present but remains confident in the longer-term growth prospects. Commentary regarding the new facility has implied revenue growth rates will be almost double those previously assumed, at 17.7% compared to 9.6% estimated previously, and the Buy rating and $4.73 target are maintained.
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