We recently researched Baby Bunting (ASX:BBN) after the Company reported a strong interim result and outlined further expansion plans via the rollout of additional stores. While there are a number of factors supporting sales growth over the short-to-medium term, are there any risks associated with the store rollout plan and what are the implications for margins?
About Baby Bunting
Baby Bunting is Australia’s largest specialty retailer of maternity and baby goods. They primarily cater to parents with children from newborn to three years of age and parents-to-be. BBN also provides services that are complementary to the products it sells, including car seat installation and car seat hire services. The Company operates 59 Baby Bunting retail stores and an online store babybunting.com.au.
BBN has more than 6,000 products, procured from a wide range of third-party brands and suppliers (in addition to private label and exclusive branded products). The Company’s private label products include products sold under the “4baby” and “Bilbi” brands. Exclusive products are sourced by the Company for sale on an exclusive basis (so that those products can only be purchased in Australia from Baby Bunting). Historically, exclusive supply arrangements have been arranged with suppliers in relation to selected products and for varying lengths of time.
Sales Growth May Be Stronger Than Expected
The Company’s comparable sales growth is expected to moderate from +12.7% over the last 12 weeks of the first half of financial year 2021 (1H21) to high-single digit % over the remainder of 2H21. This is as Baby Bunting starts to cycle an unusually strong prior corresponding period. However, there is upside to this estimate from several factors:
• The launch of new private label and exclusive products, which currently represent 39% of total sales, compared to a long-term target of 50% of sales. The ongoing expansion of private label & exclusive product has been a key driver of gross profit margin improvement in recent years. The Company is planning to introduce a new hard goods private label brand in the current half (2H21), which is expected to be accretive to gross profit margin given that these products have a higher average selling price.
• There has been a noticeable increase in the reported number of 12-to-16-week pregnancy-related ultrasounds in calendar year 2020 (+16%), which could suggest an increase in birth rate in calendar year 2021. This could prove to be a positive factor for BBN’s sales in the short term.
• COVID-19 may temporarily reduce the demand for 2nd hand products.
• Discretionary spending is likely to remain elevated in calendar year 2021 due to the higher-than-average savings rate in calendar year 2020. According to the ABS, the average savings rate over the June 2020 and September 2020 (20%) was significantly higher than the long-term average of 9%.
• While BBN’s market share has already benefitted from the closure of four major baby goods retailers (including Toys R US, Baby Bounce, Baby Savings and Bubs), there is still potential for the Company to take share from independents, discount department stores and chemists.
• Sales uplift from maturity of new stores. Baby Bunting stores typically take five years to mature. Currently, 40% of Baby Bunting stores are less than five years old and in their growth phase. Hence, as these stores mature it could represent a significant revenue opportunity for the Company, noting sales typically increase by 59% between Year 1 and Year 5.
Over the medium term, there is scope for the Company’s store rollout plans – where BBN is planning to accelerate the number of new stores in FY22, with a medium-to-long term target of over 110 stores – to support a further expansion in sales. Importantly, the strong balance sheet allows the Company to organically fund its store rollout program – as it has done historically.
Margin Expansion Is Slower Than Expected
BBN’s operating costs have risen materially in recent years, as the Company is investing ‘ahead of the curve’ in price, logistics, eCommerce and private label/exclusive brands. In turn, the increased investment has effectively delayed the potential margin expansion on offer.
It is worth commenting on the potential impact on group margin from the Company’s planned expansion into NZ, with the Company planning a rollout of at least 10 stores, which would give the Company a meaningful market presence in NZ.
The dynamics of the NZ market are such that value is a key driver of purchase, with NZ consumers considered more price sensitive in comparison to Australian consumers. As such, there is a larger representation in discount departments stores. While NZ, as a more value-focussed market, presents a risk in terms of potentially lower gross profit margin in NZ, the Company would have to manage its cost structure tightly to maintain margin at the operating level.
The shares are currently trading on a 1-year forward P/E multiple of ~26x. While this is not overly demanding in the context of forecast EPS growth of ~21% over FY20-23 on a CAGR basis, it is above the upper end of the range over the last four years.
A strong pipeline of new stores, combined with the maturation of recently-opened stores, are expected to continue to support double-digit sales and profit growth over the longer term. However, in the interim, we would prefer to see more tangible evidence of execution on a number of fronts, namely, i) Stronger operating leverage as recently-opened stores mature and ii) Expansion of the store network (especially into the higher-risk NZ market – BBN’s first foray offshore) without any impact on margin/Return On Invested Capital.
BBN appears to be consolidating now in a range between about $5 and just under $6. It is in the midpoint of the range so this means that it is too early to be a buy. We either need to see it back near $5, and hold, or we need to see a clear break above $6.
Michael Gable is managing director of Fairmont Equities.
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