Market Misunderstands Breville’s Strategy

Australia | Aug 19 2021

This story features BREVILLE GROUP LIMITED. For more info SHARE ANALYSIS: BRG

While Breville Group faces short term supply chain risks, brokers focus on the longer-term growth opportunity and attractive margins.

-Breville Group delivered a 20.5% year-on-year earnings increase 
-Gross margin fell -15bps due to higher freight costs and FX headwinds
-A significant opportunity to gain market share in Europe
-Global expansion and higher reinvestment underpins the long term
-Supply chain and transitional demand risks

By Mark Woodruff

In a result that was difficult to fault, Breville Group ((BRG)) reported a 20.5% year-on-year earnings increase that was in line with company guidance, though marginally below consensus forecasts.

Increased consumer demand driven by work-from-home, coupled with successful geographic expansion, offset the impact of intermittent supply challenges.

The company designs, develops and sells small electrical appliances branded either as Breville, Sage or a third party brand.

The Global Product segment sells products designed and developed by Breville that may be sold directly or through third parties. The Distribution segment markets products that are designed and developed by a third party, which may be sold under a brand owned by the company (eg Breville or Kambrook) or may be distributed under a third party brand, like Nespresso.

A key feature of the FY21 result was 37% constant currency revenue growth for the Global Product segment, with all regions contributing strongly. This included a 27.6% rise for the Americas, 58.4% for Europe, Middle East and Africa (EMEA), and Asia Pacific (APAC) climbed by 37.4%.

A final fully franked dividend of 13.5 cents was declared. While down from 20.5 cents in the previous corresponding period, management had previously reduced its dividend target payout ratio to 40% from 70%, on a full year basis. This was to allow continued funding of growth opportunities on a ‘sustainable cash-neutral’ basis.

Gross margin fell -15 basis points reflecting higher freight costs and foreign exchange headwinds, which was partly offset by lower promotional spend and an improving premium product mix.

Management noted no noticeable change in consumer behaviour in regions with well-progressed vaccine rollouts (US and Europe) and the company’s products are still being supported by the continued work-from-home trend.

UBS believes investors should focus on the impressive top-line momentum and the incremental investment of -$49m. This was incurred on research and development, marketing and IT, which are mainly of a ‘discretionary’ nature and could have been dialled-down to drive a material beat over consensus forecasts. The broker retains its Buy rating and $35.70 target price.

Future drivers are expected to come from strong industry demand, a return to ‘equilibrium’ of inventory over FY22 and increased new product commercialisation. Additionally, there’s expected to be a continued ramp-up in EMEA and a greater portion of marketing spend towards demand generation, via digital content and direct engagement.

While expecting top-line sales growth to moderate for APAC in FY22, Ord Minnett believes this should be offset by growth in the Americas and EMEA. The broker lifts its target price to $30.50 from $28 and retains its Hold rating.

Credit Suisse broadly agrees and sees a return to forecast trend growth in the second half of 2022 for the Americas Global Product segment and in FY23 for APAC. 

The broker sees a significant opportunity to gain market share in Europe and retains its Neutral rating, while reducing its target price to $30.98 from $32.01, largely as a result of adjusting working capital forecasts.

Morgans highlights the strength of the balance sheet and suggests it provides optionality for new markets and possibly even M&A. The analyst marginally increases its target price to $34.00 from $33.90 and keeps its Add recommendation.

Deserving of a valuation premium?

Breville Group’s peers largely include mature international companies such as Whirlpool, Electrolux and Newell Brands. Hence, Wilsons thinks a premium is warranted due to the company’s growth focussed strategy and attractive gross margins. 

The company should achieve earnings (EBIT) growth of 10-15% year-on-year over the long-term as regional locations are added in Europe. The broker, not one of the seven stockbrokers monitored daily on the FNArena database, retains its Market-Weight rating on valuation concerns only, and lifts its target price to $26.69 from $25.18.

In full agreement with Wilsons, Macquarie points out the appeal of the group remains the duration of the growth trajectory, which is supported by internal initiatives, over and above market demand. It’s thought earnings can grow sustainably in FY22 given the pull forward of marketing initiatives, new product development and geographic expansion.

The broker maintains its Outperform rating and lowers its target price ever so slightly to $34.37 from $34.80.

Challenges/risks

Gross margin headwinds in FY22 are likely due to a weaker US dollar, supplier cost increases and logistics inflation, expects Morgan Stanley.

The analyst estimates -$20-30m of sales were missed in the fourth quarter due to supply constraints (mainly transport delays). This implies second half sales growth would have been 24-28% versus the 19% that was delivered. Importantly, those sales are expected to be captured in the first half of 2022, once supply normalises.

Given the supply chain risks and a potential transitional demand outlook, Bell Potter lowers growth forecasts and decreases its target price to $30.50 from $32.25.

Inventory constraints stem from supply chain delays, supplier chain cost pressures and parts challenges. Additionally for those countries that are opening up, consumers may begin to spend on services as opposed to goods.

The broker, not one of the seven stockbrokers monitored daily on the FNArena database, is mindful of near-term macro risks and the company’s high valuation and retains its Hold rating.

While Macquarie highlights capital inventory and receivables are temporarily suppressed, resulting in elevated cash, management is planning for a working capital rebuild in FY22.

Perhaps Morgan Stanley summarises things best by concluding that despite several short-term concerns, the group continues to strengthen its long-term position via global expansion and higher reinvestment. The broker encourages investors to stay Overweight and edges up its price target to $36 from $35.

FNArena’s database has six broker ratings with four Buys and two Holds (and equivalents) and a consensus target price of $33.59, which signals 9% upside to the last share price.

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