Baby Bunting (ASX:BBN): FY25 will be better, but will investors give it the recognition?

Baby Bunting (ASX:BBN) is the poster child for what’s been happening retailers in a cost of living crisis…on steroids.

This company is Australia’s largest specialty nursery retailer and one-stop-baby shop, having grown from one family-run shop which was opened in Melbourne in 1979. Remaining headquartered in Victoria to this day (with its national distribution in the outer suburb of Dandenong), it boasts over 6,000 product lines and well as having parenting rooms in store as a point of difference.

Baby Bunting has been struggling

At first glance, Baby Bunting shouldn’t be suffering at all, because people don’t stop having babies…right? Yes, but consumers do have alternatives such as Coles, Woolworths, K-Mart, Big W, Target and (of course) Amazon, just to name a few. The same prams, car safety seats and nappies, but at a lower price. Adding insult to injury, cost inflation hit the company substantially, slashing margins.

Shares shed 80% of their value from April 2021 to June 2023 and CEO Matt Spencer stood aside after more than a decade in charge. And it has been a subdued period since then. But is a better period ahead.

Baby Bunting (ASX:BBN) share price chart, log scale (Source: TradingView)

Baby Bunting hired former Afterpay executive Mark Teperson as its CEO. Its sales for FY24 were only down 3.4% and just fell short of $500m. The company’s profit fell from $9.9m to $1.7 on a statutory basis and from $14.5m to $3.7m on a pro forma (i.e. underlying) basis.

However, the company tried to sell investors the message that things were turning around. It pointed to initiatives such as the renegotiation of terms with suppliers and ‘simplification of elements of our pricing structure’. And the company boasted that it had 800,000 active customers, a renewed $70m debt facility with NAB and encouraging trading to start FY25. Specifically, total sales grew 3.5%, although this is only 2% on a like for like basis. Investors were told to expect a 40% gross profit margin (which had been achieved in early trading) and for a $9.5-12.5m NPAT.

Assumptions underpinning these were comparable store sales growth of 0-3%, a 40% gross profit margin, wage inflation of 3.7% and remaining costs of doing business remaining within company forecasts and $10-13m of capital expenditure. It assumed ‘no significant changes in economic and retail trading conditions, and no significant increase in sea freight expense’.

The key to a recovery

Many investors may not recognise that Baby Bunting never had that large a market share to begin with. It only boasts a 23% share in so-called ‘hard goods’ and a mere 3% in so-called ‘soft goods’, as outlined below.

Source: Company

There’s no doubt that if Baby Bunting can increase its market share, shares could re-rate. There is a Catch 22. It cannot grow its market share without investing in its stores and in marketing, and it can only invest so much while still increasing margins, and if it does not increase its margins, investors will keep shunning the stock.

Beyond a 40% gross margin, Baby Bunting is aspiring to re-establish itself as a 10% EBITDA business. We can see clear plans for this to happen. But we remain to be convinced as to how exactly it will increase. Yes, the company has a store optimisation plan in opening new stores where there’s an opportunity and either renegotiating leases or closing down at unprofitable outlets. But the company needs a plan to differentiate itself from its peers, particularly from a marketing standpoint.

Conclusion

Analysts covering Baby Bunting call for $522.8m in revenue and a $9.4m profit in FY25, followed by $561.7m in revenue and an $18.8m profit in FY26. These estimates put the company at 22x P/E and just 0.3x PEG for FY25. Nonetheless, the mean share price is $1.89, just 6% above the current price. Estimates range from $2.65 to $1.80, showing a divergence of opinion, but still a scepcticism that it can reach 2021 highs once more.

Overall, we would answer the question as to whether or not Baby Bunting is a buy as a no for the time being, but we might revisit our thesis in 6-12 months time, if we can see clearer (audited) evidence of a financial turnaround, and more details about how it can differentiate itself from its peers. Yes, it will be investing to grow…but so will the Great White Shark from Seattle.

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