We recently researched Breville Group (ASX:BRG) after the Company released results for the 12 months to 30 June 2023 (FY23). In its guidance commentary, BRG noted that it expects an FY24 result similar to FY23. This is due to macro headwinds playing against Company-specific tailwinds.
A lack of transparency around key financial measures continue to weigh on the shares. With the shares having retraced from its recent peak, are market concerns starting to be priced in?
About Breville Group
Breville Group manages 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. This business is focused on the design, development and sale of Breville-branded products. The 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, at over 50% of sales.
ii. The ‘Distribution’ segment. This business distributes products that are designed or developed by a 3rd party pursuant to a license or distribution agreement.
Key Fundamental Drivers
Breville Outperforming Peers
We have perused the results of BRG’s key competitors for the June 2023 quarter. Across the peer group, there was evidence of broad-based softness in demand for EMEA and North America. Several competitors downgraded sales guidance for the second half of the current calendar year. This was on the back of lower consumer demand.
In contrast, BRG reported positive revenue growth for the June quarter (+9.8%). This growth is mostly driven by the Americas division. The latter is the strongest performing region given the steady demand for new products and strong growth in the direct-to-consumer (DTC) channel.
Gross Profit Margin Expected to Increase – But There Are Risks
In FY23, Gross Profit Margin (GPM) improved by 70 basis points to 35.0%. Headwinds from input cost inflation, higher logistics costs and a strong US$ were offset by a strong pricing strategy with measured promotions. GPM also benefited from a trend back to a more normal inventory position.
Further GPM expansion is expected. This is due to lower international freight charges and largely hedged currency for US$ exposure. However, there are two key risks to further GPM expansion. Firstly, there is a risk of the discounting from competitors given the broadly weak sales performance from BRG’s peer group and relatively elevated inventory levels. Having said that, while there are no signs of heightened discounting at present. Secondly, in light of ongoing consumer stress, the upcoming Christmas trading period is typically a key indicator of the demand profile for BRG’s products. This will be a key factor in determining whether the Company can maintain/expand GPM.
Inventory Levels Have Peaked – But Likely to Remain Elevated
The inventory position remained elevated in FY23. By way of background, inventory levels in recent years have increased as a supply chain buffer and to support new product development. In turn, this has resulted in the balance sheet reverting from a net cash position at the end of FY21, to a net debt position currently. As such, the high inventory levels have been a key factor impacting investor sentiment.
At the FY23 results release, the Company commented that it expects lower inventory in FY24, leading to lower debt and interest costs. BRG commented that it does not intend to discount in order to accelerate stock clearance and that they expect cash conversion of ~100% in FY24. This is likely as more predictable patterns emerge from retailers that lead to more normal inventory levels.
Having said that, we do not expect a material reduction in inventory. This is because the upcoming launch of new products across different markets (and entry into new markets) requires additional inventory.
The shares are currently trading on a 1-year forward P/E multiple of ~25x, which is at the top end of the recent trading range and at a premium to its peers. The premium reflects the strong recent sales performance relative to peers. It also reflects the medium-term growth opportunity from successful expansion into new geographies, expanding market share new product development.
Relative to an EPS growth profile of +13% over FY23-26 (on a CAGR basis), we consider these factors to be well reflected in the current multiple. Further, earnings risk over the short-term is skewed to the downside, as evidenced by factors such as:
i. The potential for discounting to reduce inventory levels which in turn impact GPM,
ii. Higher-than-expected re-investment, which may impact EBIT margin;
iii. Higher debt levels which restrict balance sheet capacity and lead to higher net interest charges.
Over the past year, Breville was forming an ascending triangle with a level or resistance in the mid $22’s. It managed to break above that in early August, but it has failed to kick on. It is now retesting that old resistance line, but short-term price action is weak. We wouldn’t be surprised if it struggles to gain support here. If that is the case, then we would be looking for levels closer to $21. Investors looking to get into BRG can therefore be patient for lower levels.
Michael Gable is managing director of Fairmont Equities.
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