There are several factors that are expected to support Baby Bunting ((BBN)) over the next couple of years, including containment of the pandemic in Australia, more flexible working conditions and a relatively resilient economy.
The company was one of the few Australian retailers not to benefit from JobKeeper or material reductions in rent, which Morgan Stanley points out will mean less onerous numbers are being cycled over FY21.
While the broker upgrades estimates by 7%, if comparable momentum continues, significant upside is envisaged. Revenue rose 16.6% in the first half with operating earnings (EBITDA) up 29% and net profit up 43%.
Online sales grew 100% and private-label/exclusive comprised 39% of the total. Citi envisages like-for-like sales momentum will ease back to 7% over the rest of the second half, relative to the increase of 18.5% experienced in the first six weeks. Ord Minnett agrees the rate of growth will moderate progressively, particularly over May/June.
No guidance was provided but Macquarie considers this understandable in the light of retail uncertainties, and this category is typically more resilient. The supply chain impact was larger than the broker anticipated, given the extended lockdowns in Melbourne but also the tightness of container availability for a lot of importers.
In Macquarie’s view, Baby Bunting is one of the few retailers likely to sustainably grow earnings in FY22. The mix of home delivery versus click & collect has changed since the end of the most onerous period of Victorian lockdowns, and data mining signals the importance of the physical store network for the category.
Upside could come from the increase in the number of births – as Citi quotes 12-16 week pregnancy-related ultrasounds increased by 16% in 2020. On the other hand, the pandemic is likely to suppress the demand for resale of used products.
Macquarie notes demographers have pointed to a fall in birth rates from the pandemic but considers this information “backward looking”. A decline in fertility rates for the six months to December is considered typical of periods of economic downturn and declining job security.
Hence, a rebound in economic activity should mean improvements in official fertility rates will come through over 2021. Morgans suspects, too, that this time the traditional concerns regarding unemployment that prevail during pandemics, which causes birth rates to fall, could be less of an issue in Australia.
While the stock’s valuation is at a premium to retail peers, the broker points out the growth profile is far superior and a heightened birth rate could provide a robust backdrop over the next year or so.
First half gross margin expanded 41 basis points to 37.4% although higher costs and increased online sales caused this to pull back in the second quarter. Gross margin is expected to expand further, nevertheless, as new private-label and exclusive hard goods are launched.
There are also lower-margin nappies and consumables sales to be be cycled from March-April 2020. Higher-margin toys and games are back in stock following supply issues in the second quarter.
Morgan Stanley notes the company has accelerated its share of business and returned the benefits of scale to its value proposition. The broker remains bullish on the outlook for margins although suspects reinvestment may be limiting operating leverage and this can be an issue for investors.
The company is investing ahead of the curve in terms of price, logistics, e-commerce and private label. This delays the potential for margin expansion.
Another concern is the increase in working capital which is ahead of previous years. The broker suspects gross margins were likely understated in the first half, given higher freight costs as well as the high-margin categories being affected by supply disruptions. A new private-label brand in hard goods is planned in the second half, expected to be accretive to margin.
Baby Bunting plans to increase its number of stores in Australia to over 100 and will roll out its first New Zealand store in FY22, targeting a network of more than 10 stores. Macquarie notes Baby Bunting is now just halfway through its planned store roll-out and the growth potential has now been extended with the additional NZ target.
Morgans expects the current NZ plan will be modestly dilutive to profit in FY22 before becoming profitable in FY23. The broker assumes four NZ stores are rolled out per annum and 14 are in place by FY25. Morgans assumes gross margins will be in line with Australia with a slightly lower margin over the ramp-up phase.
Forecasts for FY23 are lifted by 8%, and even more so in future years, to include the roll-out in New Zealand, and the broker upgrades to Add from Hold. FNArena’s database has five Buy ratings. The consensus target is $6.25, suggesting 15.8% upside to the last share price. This compares with $5.28 ahead of the results.