Baby Bunting’s Margins Go Out With The Bathwater

Small Caps | Oct 13 2022

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

Baby Bunting has implemented plans to address a -230 basis point gross profit decline year-to-date and analysts expect some recovery can be made. 

-Baby Bunting has reported a -230 basis point decline in gross profit margins
-Poor execution of its loyalty program was a key driver of the decline
-Plans have been implemented to secure margin and earnings recovery throughout the remainder of the year

By Danielle Austin

Following four years of consecutive year-on-year improvement, Baby Bunting ((BBN)) has suffered a -230 gross profit margin basis point decline in its first quarter of the fiscal year, disappointing analysts. In a breakdown of the decline, -60 basis points have been attributed to poor execution of the company’s loyalty program, with greater than expected loyalty program redemptions, -70 basis points to domestic freight rates, -20 basis points to foreign exchange rates and -60 basis points to Playgear. 

Having implemented plans to address these impacts, Baby Bunting expects it will be able to recover earnings over the full year. Analysts largely expect some gross margin recovery throughout the rest of the fiscal year.

On the bright side, underlying sales trends remained positive for the retailer, supported by the opening of three new stores in the quarter. Baby Bunting reported total sales growth of 12% and comparable sales growth of 8% on the previous comparable period in the first fourteen weeks of the year. With the company achieving 15% growth in the first six weeks, this does represent a slow down in growth to 2% in the latter eight weeks, likely due to tougher comparable sales. 

Analysts expect loyalty program to drive margin improvement

Four database brokers covering the stock have updated on Baby Bunting’s first quarter. These brokers have an average target price of $4.41, ranging from $3.32 to $4.95. All brokers largely expect some margin decline moderation to occur over the remainder of the fiscal year, derived from optimisation of the retailer’s loyalty program.

Macquarie (Outperform, target price $4.95) anticipates the gross profit margin decline to moderate to -200 basis points over the first half. The broker also expects foreign exchange rates to have a more significant impact throughout FY23, and domestic freight prices to continue to be volatile in response to oil price movements.

While expecting gross profit margins to remain under pressure, the broker believes store rollouts and market share gains can support top line growth. It forecasts total sales growth to moderate to 4.8% over the first half. Macquarie has downgraded its earnings per share forecasts -25%, -18% and -8% through to FY25. 

Surprised by the extent of Baby Bunting’s margin decline, Citi has downgraded to Neutral from Buy (target price $3.32), considering the company to be at risk of further earnings downside from margin pressures. While anticipating some margin pressure relief, the broker predicts a -170 basis point decline over the first half. Given the greater than expected sales growth slow down following the first six weeks of the year, Citi anticipates sales growth of 5% over the first half, implying growth of 2% in the remaining twelve weeks. 

The downside surprise of Baby Bunting’s update drove Morgan Stanley (Overweight, target price $4.60) to decrease its estimates between -14-20% for FY23-FY25, but it does expect the retailer can recover margins to historical peaks. Given the decline is not a demand issue, Morgan Stanley remains confident it is transitory and a reflection of the company’s focus on customers over margins in the quarter. Baby Bunting has taken steps to remedy the issue, which the broker expects to emerge on a lag.

Ord Minnett (Buy, target price $4.75) expects margins to decline in the first half, and to moderate to a -140 basis point loss over the full year to 8.3%. The broker expects cycling the introduction of the loyalty program to support some recovery. Noting this presents a near-term challenge for the retailer, Ord Minnett continues to assume above average medium- to long-term growth, underpinned by ongoing store openings in Australia and New Zealand.

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