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Baby Bunting’s Growth Spurt To Slow, A Little

Australia | Feb 20 2017


Baby goods retailer Baby Bunting is investing in price & customer service, and brokers believe this is paying off in terms of market share.

-Gross margins soft in first half but attributed to shift in sales mix
-Sales growth to moderate over the second half
-Medium-term growth outlook seen captured in share price


By Eva Brocklehurst

Baby Bunting ((BBN)) is growing strongly. First half results were broadly in line with broker estimates although gross margins were soft. Morgans believes the company's strategy of investing some of its top line back into prices and customer service is the right one and should confirm the company's proposition as a category killer in the baby/nursery goods segment.

Baby Bunting delivered 8.2% sales growth in the first half. Morgans notes this implies like-for-like sales growth over the last seven weeks of around 3.1%, given 10% was reported for the first 20 weeks. This represents, in the broker's view, a reasonable slowdown towards year and. Gross margins were below expectations because of the focus on price and customers. Online investment is observed to be paying off, and now comprises 5.9% of group sales.

Store Footprint To Double

The main attraction for Morgans is the fact that around 43% of the stores are less than three years old and the company has a net cash position. In the meantime, the competition is struggling to remain viable. The broker believes the company can assert its ascendancy over competitors in coming years and its store footprint can double. The broker downgrades its recommendation to Hold from Add on valuation grounds only.

The company reports trading in FY17 to date shows sales growth of 8%, implying around 7.6% like-for-like growth in the first six weeks of the second half. The trend, Morgans observes, continues to be solid. Management expects sales growth will moderate over the balance of the second half as the group cycle stronger comparables.

Gross margins were slightly softer than Macquarie expected too and, as also expected, like-for-like sales growth is moderating throughout the year as the previous corresponding period becomes increasingly tougher to beat. FY17 operating earnings guidance (EBITDA) of $21.5-24.5m represents growth of 15-31%, the broker calculates.

Macquarie's previous forecasts were at the top end of the guidance range and this now appears a stretch. The broker revises estimates to assume around 7% like-for-like growth with less operating leverage in the second half.

While lowering near-term forecasts, Macquarie emphasises the medium-term growth outlook is attractive but this is currently captured in the stock's price, given a 50% price/earnings ratio premium to the market. Hence, Macquarie downgrades to Neutral from Outperform.

The medium-term outlook remains intact in the broker's view. Three new stores are to be opened in the second half and the broker notes the group is only around half way to meeting its medium-term store target of around 80.

The result was just below Morgan Stanley's estimates but the miss is not considered material, considering the difficulty in forecasting six months for a company in a strong growth phase. The broker envisages both new and maturing stores are an opportunity for revenue growth and margin expansion.

With potential to more than double its store count and the benefits from scale, Baby Bunting should be able to maintain earnings growth above the market rate for a long time, Morgan Stanley suggests. The decline in the gross margin was unexpected but the broker attributes this to a shift in mix that resulted in higher sales, and believes this shows how the company continues to invest in price to expand its market share.

The industry is highly fragmented and the broker believes the competitive advantage of Baby Bunting will only strengthen as it extracts the benefits of scale.

Risks to the outlook include a competitive threat from online and international retailers and a depreciation in the Australian dollar which increases buying prices. Morgan Stanley also notes there is a risk the retailing of baby goods proves too hard to corporatise effectively while the Australian consumer environment remains challenging.

Baby Bunting has one Buy rating (Morgan Stanley) and two Hold on FNArena's database. The consensus target is $2.81, suggesting 22.3% upside to the last share price.

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