We recently researched Breville Group (ASX:BRG) in The Dynamic Investor after the Company released results for the six months to 31 December 2023 (1H24). Like many consumer-discretionary stocks, BRG has recovered well from its lows in late 2023 and has somewhat regained its premium rating. Accordingly, we assess whether the shares present value at current levels.

About Breville Group

Breville Group (BRG) manages of a number of consumer electrical appliance brands, with a core focus in the small kitchen appliances segment. The operations of BRG now comprises two segments:

i. The ‘Global Product’ segment – focused on the design, development and sale of Breville-branded products supplied in 65 countries to the premium kitchen segment of the market. This segment accounts for 80% of group revenue and comprises contributions from three regions: Americas, Asia Pacific (APAC) and Europe Middle East and Africa (EMEA). The America region is the largest region for global product, accounting for 50% of sales.

ii. The ‘Distribution’ segment, which distributes products that are designed or developed by a 3rd party pursuant to a license or distribution agreement. The distribution of these products may be sold under a brand owned by BRG (e.g. Breville, Kambrook) or distributed under a 3rd party brand (e.g. Nespresso).

Key Fundamental Drivers

Is Market Share Loss a Concern?

Overall sales growth of 2% in 1H24 was led by weaker results in ANZ and the Americas. Further, it appears that BRG lost some market share over 1H24 based on peer results, with DeLonghi highlighting mid-single digit growth in the global coffee category.

Market share loss is considered a more of a short-term impact for BRG ahead of New Product Development (NPD) in light of several factors:

i. BRG is seeing increased SKU counts across key customers.
ii. NPD is resonating and selling well based on recent launches with a strong pipeline to come.
iii. BRG has solidified position in premium space through maintaining price and brand integrity.
iv. Sales in 2H24 are expected to rise by ~5-6% y/y, with this momentum set to continue into FY25 on the back of several factors. These include a significant improvement in industry inventory, as well as an expected material contribution from NPD in FY25. Also, there is some scope to take price increases into FY25 via NPD.

Stronger Margin Performance

Gross Profit Margin (GPM) continues to benefit from strong pricing strategy with measured promotions as well as a more normal inventory position. The expansion in GPM in 1H24 (to the highest level since FY12) was also driven by an increased focus on higher-margin sales through the 1H24 period. BRG is not following competitors down the path of heavy discounting in order to stimulate sales.

The stronger-than-expected expansion in GPM were achieved through lower input costs, notably freight, and a “controlled” approach to promotional activity.

Supported by the uplift in GPM, EBIT margin improved by 90 basis points, with ~50% of gross profit growth flowing through to EBIT. The Company is increasing its portion of spend on investment functions (Research & Development [R&D], marketing, technology service and solutions). The Company’s focus is on functions that drive revenue growth (via new products, higher brand awareness and an improved competitive position). In turn, this factor underpins the expectation for moderate EBIT margin expansion over the medium term.

Whilst there is strategic merit in the Company’s strategy to prioritise gross profit growth over sales growth, we are not convinced that the market is entirely on board with this strategy. In particular, for BRG, gross profit/EBIT growth doesn’t necessarily have to come at the expense of sales growth. In particular, BRG could have partly reinvested the savings into retailer promotional programs. This could have delivered higher sales growth than the +2% reported and limited market share loss.

Balance Sheet Position Strengthens as Inventory Levels Are Normalising

The balance sheet held net debt of $97.5m as at 31 December 2023, down from $121m as at 30 June 2023. The reduction was primarily due to lower inventory levels. This reflects the normalisation of the global supply chain and the removal of safety buffers to mitigate against disruption. Importantly, the reduction in inventory is attributable to measured purchasing reductions, rather than discounting.

Reduced inventory levels will drive a working capital release; hence a small net debt position is expected by the end of FY24. Net debt as at 31 January 2024 had reduced to $34.7m. Further, BRG continues to have substantial headroom, with gearing (on a net debt to EBITDA basis) of 0.4x and sufficient funding in place for expansion.

Fundamental View

Whilst the strong negative market reaction to the 1H24 result resulted in a large drop in the share price, there has not been a material de-rating in the shares. This is despite minor downgrades to EPS forecasts for FY24-26 post 1H24 results release on the back of minor revenue downgrades.

BRG shares are currently trading on a 1-year forward P/E multiple of ~29x, which compares to ~30.5x pre-results. In context, EPS growth profile of over FY23-26 (on a CAGR basis) was +15% pre-results and following EPS downgrades post results release, has declined to +10%. This makes the risk/reward ratio trade-off riskier. As such, there is potential for a further de-rating in the shares should the market form the view that sales growth in FY25 is unlikely to accelerate materially.

Charting View

Since bottoming out in 2022, we can see that BRG has generally traded in a coupe of well-defined channels. At the moment it is near the top of the current channel. Unless we can get an upside break, the most probable path from here is back towards the lower end near $24. Investors looking to buy BRG can therefore be patient and wait for those cheaper levels.

 

Michael Gable is managing director of Fairmont Equities.

 

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