”Nothing is certain except death and taxes” (Benjamin Franklin, 1789)
Things that are certain, like Death and Taxes, cause an inherent core demand for products and services. Whole industries were created because of these types of core demands, and these industries are very attractive because they’re essentially indispensable: these businesses don’t need to convince customers of the need for their services, they just need to be the most popular service provider!
A number of other businesses also have extremely strong core demand because every human needs their product/service. Today’s business is driven by BIRTHS - Old Ben is only partially right – Death is only certain because Births keep happening. When you have a baby, you need to buy some new things. Lots of new things. More things than you ever thought you would need to buy when you have a baby. The core demand for baby-related things is enormous!
Baby Bunting (ASX: BBN) has been around since 1979 and markets itself as “Australia’s largest specialty nursery retailer and one-stop baby shop”. It scores very highly on brand recognition and tries hard to be in front of as many expectant parents as possible, with 70 stores across Australia and New Zealand, and a 22,000sqm distribution centre in Melbourne.
Baby Bunting should be a healthy business: babies keep being born (Australia’s fertility rate rose to 1.66 babies per woman in 2020/21 thanks to Covid), Covid supply chain issues are largely resolved, and they’ve expanded across the ditch to NZ. So why have their shares dropped to a 5-year low after announcing their FY23 results?
Baby Bunting FY23 Highlights
Pretty much all of Baby Bunting’s FY23 financial highlights are actually really bad lowlights:
Gross Profit is down 1.18% to 37.4%
EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation) is down 38.2% to 6% of Sales
NPAT (Net Profit After Tax) is down 51% to $14.5m
Free Cash Flow (Cash leftover after paying Operating Expenses and Capital Expenditure) is down 36.7% to $11.9m
Earnings Per Share down 52.2% to 10.8 cents per share
Full Year Dividend (earnings paid to shareholders) down 51.9% to 7.5 cents per share
The only almost-positive is that annual sales have increased 1.7% to $515.8m in FY23 … but FY23 was their year of expansion, and they opened 7 new stores (2 in Victoria, 2 in NSW, 1 each in QLD & SA, and one in NZ) so sales from the existing stores dropped by 3.6%, so actually this sales growth is bad news☹
So what’s gone wrong?
External Analysis
Baby Bunting is a business that runs on core demand, because babies just continue to be born, right? Money for jam?
WRONG!
Australians are definitely not churning out babies like they used to. 2021 was a bumper baby year because Covid lockdowns and crappy daytime tv led to a bumper baby year – in fact the highest ever recorded. But after that births returned to trend, and that trend is downwards.
(courtesy of Statistica)
2022 data is half year only – so the downward trend continues. This trend is a worldwide one, because fertility rates are decreasing worldwide:
Not only are Australian birth rates declining, but the market is changing. 5 years ago Baby Bunting commanded a premium position in the market – when times are good and parents have large disposable incomes, premium brands attract sales from perceptions of high quality. Our post-Covid world is different though. Quality perceptions have become less important as Baby Bunting’s competitors offer bargains and savings at a time when interest rates are mugging family budgets. Kmart, Big W, and Target offer cheaper products and availability across more of Australia, so Baby Bunting prides itself on being the largest “Specialty” maternity & baby goods retailer. Is being a specialty retailer going to be enough in FY24? The financial markets don’t think so.
So, this means …
2 pieces of bad macro-level environmental influences on Baby Bunting:
Short Term: Monetary policy raising interest rates is pushing clients to find cheaper alternatives.
Long Term: Baby Bunting has been operating in a slowly declining market and this will continue.
What can Baby Bunting do?
Operating in a declining market means you can only really grow by taking market share from your competitors faster than the market shrinks. Baby Bunting has realised its major threat lies in the erosion of purchasing power due to inflation pushing customers to lower-cost competitors. To counter this they have embarked on a multi-pronged strategy of:
Moderately aggressive store expansion in FY22 (4 stores) and FY23 (6 stores).
Maintaining online sales channels (both Delivery and Click & Collect) however these have reduced over FY23, with online now 20% of total sales.
Increased effort to retain existing clients so they don’t slip over to the dark side (Kmart, Big W, Target) by focusing on using its Loyalty program to bind their clients more.
Grow internal generic alternatives to premium brands – Private Label allows Baby Bunting to compete with generic brand alternatives of Kmart, Big W and Target.
Is it working?
The answer is a resounding and disappointing: not yet:
Their FY23 results announcement heralds some successes that don’t quite stack up … yet:
Australian store network is 70 stores with a plan to reach 120+ which would give them roughly as many stores than Target and potentially give them number 3 spot, however the competition from a merged Kmart/Target will likely cause headaches for Baby Bunting, especially as high interest rates continue to reduce consumer purchasing power over the next couple of years.
Development of Private Label products to fight non-premium brand competitors doesn’t seem to have helped yet. Boasting that around 80% of your top SKU’s are not available on Amazon or Catch and only 1% of sales came from your “Price Beat Promise” sounds impressive, but when your Private Label & Exclusive Brand products make up 45% of your total sales and Gross Profit % has reduced, it really says that you’ve shifted your position to build your own lower-margin non-premium brand in order to grow sales. It’s hard to imagine this strategy being competitive with a merged Kmart/Target who will be much more efficient at selling at lower margins.
Moving to a lower margin sales model would be a sound decision in this economy if you can make your organisation more efficient in order to maintain bottom line profitability. Baby Bunting has not managed to do this – Gross Profit is down 1.18% but its Cost of Doing Business (operating expenses) have increased by 2.72%! They’re predicting $6m to $8m of cost reductions in FY24 which should add circa 1.3% to next profit … if they eventuate.
So Baby Bunting has embarked on a strategy that has decreased their margins, increased operating costs, reduced profit and consequently reduced Equity (Net Assets) by $6.8m (5.9%), most of which has reduced cash by $7.2m (40.9%) year on year.
Will it work in future? Yes, but …
Baby Bunting has a history of opening new stores that gives them solid data on when they reach maturity. It takes about 4 years for them to turn an acceptable profit:
This data is based on a store profile that is mostly Metro-based. Regional store revenue will be roughly half at $4.7m annually, but still be generating around 19% EBITDA.
Value Analysis
Positive:
BBN now has existing infrastructure in both Australia and New Zealand to support store growth.
Its private label & exclusive brand categories give it control over product assortment and should compete with a combined Kmart/Target and Big W in the non-premium and semi-premium space.
Admin, Warehouse and Marketing expenses have already been reduced in the second half of FY23 and these savings are ongoing, plus a further $6m-$8m planned for FY24.
Successful history of new store openings in regional, destination and shopping locations means expansion to 120+ stores is within capability.
Negative:
Capacity to roll out new stores quick enough is constrained. Cash reserves have been drained substantially during FY23, and it takes 4+ years for a new store to earn back its capital investment.
Reliance on existing lending facility to fund future expansion means Interest costs will rise substantially over the next 2-3 years.
Risk involved in opening a large number of new stores in a retail environment that is predicted to worsen over the next 1-2 years.
The amalgamated Kmart/Target will move Baby Bunting into number 3 spot behind Big W, but will increase competition especially in the non-premium market. This will put pressure on Baby Bunting’s Private Label and Exclusive Brand products, particularly in Consumer Staples and Play Time products which have both already decreased around 7% each in FY23.
Overall
Baby Bunting has tried to position itself well for expansion off the back of a Covid baby boom, but it is right in the middle of a perfect storm:
Baby birth numbers have returned to their long-term downward trend.
Customer purchasing power has been eroded by inflation and high interest rates.
Competition for sub-premium and non-premium baby products has increased and will increase with the merger of the two largest retailers of these in Australia.
Baby Bunting has the right ingredients to implement a successful expansion strategy in normal times, but these times aren’t normal. There is huge downside risk to its strategy, compounded by its lack of capital meaning this growth must be financed through lending, further eroding its Equity problems after a poor FY23 performance.
Remember this? “Operating in a declining market means you can only really grow by taking market share from your competitors faster than the market shrinks.”
Baby Bunting heads into FY24 after positive financial performance in the second half of FY23. Unfortunately it's also about to embark on further expansion during a period in which they'll see customer drift away from premium products and towards sub-premium and non-premium. Baby Bunting's Private Label and Exclusive Brand products will absorb some of that drift, but competition in that space will increase dramatically as the number 1 & 2 competitors in the market merge.
So Baby Bunting may have an ok FY24 and start to build some cash and equity in the business again, but its expansion plans and susceptibility to macro-economic trends and competition mean it’s not financially in a good enough shape to take market share faster than its competitors, who are firmly entrenched, and extremely good at selling the types of products people will be spending more on over the next 2-3 years. It has an ambitious expansion plan that it can’t fund without putting further stress on profits, so is looking more like a takeover opportunity at the moment than a seriously successful growth business.