Baby Bunting A Victim Of Its Own Success

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

Baby Bunting has signalled FY18 earnings will be be flatlining, as heightened discounting among competitors is putting pressure on margins.

-Investors likely to pause for evidence that conditions are stabilising
-Comparables will get easier, along with the realisation of scale benefits
-Stock can return to strong profit growth if it capitalises on share opportunity
 

By Eva Brocklehurst

There is a difficult period ahead for Baby Bunting ((BBN)) as competitors step up promotional activity ahead of closing down. The company has downgraded guidance for FY18, expecting operating earnings (EBITDA) to be flat versus FY17, at around $23m.

Guidance is based on a normalising of trading conditions through the second half but no price recovery is assumed. New stores are expected to contribute around $12m in sales but this will be weighted to the second half because of delays. Supply problems with a car seat manufacturer have also affected the company sales by around -$2m in the year-to-date.

Gross margins are expected to decline to around 33.3% but also improve in the second half, supported by more exclusive ranges of baby goods, improved supplier terms and direct importing. Macquarie believes FY18 guidance is achievable, assuming around 4% like-for-like sales growth.

Moreover, omni-channel and customer experience investment will improve the company's competitive positioning going forward. Limited catalysts exist for the near-term and weak sector sentiment overall is likely to mean investors pause while awaiting evidence that conditions are stabilising. This supports Macquarie's Neutral rating.

The trading update suggests like-for-like sales growth for the five weeks to November 13 slowed to flat and, while market share gains may help the company deliver on its guidance, Citi remains cautious in the face of current conditions.

Rationalisation

Industry structure is improving over the medium to longer term while, in the meantime, ongoing sector rationalisation represents the near-term risk. Management expects to be able to grow market share once this activity cycles through.

Morgan Stanley flags a recovery in the second half, when competitors have closed their doors and comparables get easier, along with the benefits of scale being delivered. The broker calculates that around 7% of specialist baby good stores in Australia have closed in the last three months and this has motivated excessive clearance and discounting activity.

The broker remains confident the situation will improve in the second half as the store closures strengthen Baby Bunting's presence in the industry, suggesting there is around a $25m revenue opportunity in the short term. The company has guided to an improvement in gross margin, as extra benefits of scale are extracted, without presuming a recovery in price.

The stock is cheap and Morgan Stanley suggests the current share price ignores the embedded growth from the fact that 46% of stores are less than three years old and there is the opportunity to double the store footprint to around 80. Countering this, any aggressive move and/or pricing in this category by Amazon would pose a risk.

Citi also cites downside in the short term from the pending entry of Amazon. The broker maintains a Neutral rating given the potential for further disruption and the risk of a pulling forward of demand from elevated discounting. While sector consolidation could be viewed as a positive over the medium to longer term, the broker expects sales and margins will be affected by the additional closures.

Morgans is prepared to be patient, believing the stock can return to strong profit growth from FY19 if it capitalises on the market share opportunity. The company has pointed out that since the closure of Bubs in September in Western Australia, its stores in the same catchment have seen 17% sales growth, which Morgans suggests is the first clear sign the company is able to capture a significant portion of the market share that is up for grabs.

FNArena's database shows two Buy ratings and two Hold. The consensus target is $1.64, suggesting 20.8% upside to the last share price. The dividend yield on FY18 and FY19 forecasts is 5.1% and 6.2% respectively.
 

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