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Breville (ASX:BRG) is one of those consumer stocks that has been sold off over fears that it will be hit by inflation. It is also a stock we think represents an opportunity for investors, because nothing is further from the truth.
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Who is Breville?
This company is a premium kitchen appliances business with a presence in Australia, Europe and the Americas. It was founded in 1932 – founded from capital obtained from a successful 4-to-1 bet at the 1932 Melbourne Cup.
Breville sells over $1.4bn in goods each year in over 100 countries globally and caters to middle to higher income earners. It is headquartered in Sydney, has manufacturing facilities in China and regional offices in key markets.
The shares are rangebound
Breville listed in 1999 and has achieved growth of over 2000% since. In the last 10 years, it has gained 200%. In FY22, it generated $1.4bn in revenue (up 19.4%), $156.4m in EBIT (up 14.6%) and a $105.7m NPAT (up 16.2%). It recorded 34.3% gross margins and an 11% EBIT margin in FY22.
In 1HY23, it achieved $888m in revenue (up 1.1%), $121.1m in EBIT (up 7.6%) and a $78.7m NPAT (up 1.3%). In the last three half years, it had paid 15c per share, which is a yield of 1.4% on an annualised basis. Its Return on Equity fell from 19.7% in 1HY22 to 16.1% in 1HY23.
Breville shares are down 35% since reaching an all-time high in mid-2021 and have been trading in a range of ~$17.70 to $23.20 in the last 12 months.
Why Breville has been sold down
We see five reasons why. First, fears that inflation will impact demand. But if you look at the company’s group-wide results, this has not been the case. However, there was a decline in sales in Europe due to the war in Ukraine, while group sales were buoyed by a solid performance in the Americas. Investors perceived the European decline as more important than American growth given the higher degree of vertical integration between markets in Europe.
Secondly, fears that the company will be hit by cost increases and supply chain issues. Granted, Breville manufactures in China and supply chain disruptions have happened to competitors, such as Whirlpool, KitchenAid and De’Longhi. Still, the company has taken some steps, such as acquiring Italian coffee machine maker Lelit in mid-2022.
Third, the company’s inventory uplift in FY22. Inventories doubled to $445.9m in FY22 to improve stock availability. The company went from a $129.9m net cash position to $4.1m in net debt. Investors have not liked stocks with such significant uplifts in inventory given the potential to over-estimate demand and have to discount to clear inventory – as Kogan (ASX:KGN) had to do during the pandemic. The difference is that Kogan bought inventory anticipating that peak demand would last forever whilst Breville just wanted to keep up with ordinary levels of demand.
Forth, concerns about R&D spending levels. Breville spent $26.1m on R&D work (up 15% from FY21) and a further $15.7m in 1HY23 alone (up 47%). The company sees this as an investment into its future, but it comes at the expense of short-term cashflow (although R&D expenditure is only 2% of receipts from customers).
What does the future hold?
The company’s only guidance for FY23 is that it expects full year EBIT to be $165-$172m, which would be 5-10% growth on the previous year. This guidance was reiterated at its 1HY23 results in February along with the recent Macquarie Equities Conference.
There are 15 analysts covering Breville and their estimates for FY23 call for $1.48bn in revenue (up 4.2%) and $208.7m EBITDA (up 11.7%). Looking to FY24, estimates call for $1.6bn in revenue (up 8%) and $229.5m in EBITDA (up 10%). With these estimates, Breville is trading at 14.6x EV/EBITDA and 24.5x P/E for FY24.
We have built our own DCF model for Breville and we think it is worth $30.33 per share, representing 42% upside from the May 4 closing price ($21.36). We have followed consensus estimates, used a 9.84% WAAC (representing a 1.1 beta, a 4.5% risk free rate of return and a 5.5% equity premium, along with a 2% terminal growth rate).
Why we’re confident about Breville
We think there are four reasons why Breville can grow. First, it’s track record of sales growth with 14.6% CAGR in EBIT over the last seven years. While this isn’t a guarantee it can achieve the same results, it does inspire confidence.
Second, the company’s experience in successfully entering new markets. We note that it hasn’t been as active in Asia as an Australian company with a global distribution network probably would be. But it entered South Korea last year and has been successful in doing so. In our conversations with the company, it has noted ambitions to enter further countries in the region. Entering new European countries could be done far easier given its existing network. The company estimates 70% of its revenue potential is unaddressed and it could ultimately achieve $9.7bn in revenue.
The third reason is the market the company is in. Breville offers premium and functional goods, targeted at consumers with higher disposable income. It is therefore less likely to be hit by a slowdown in consumer spending, at least to the extent of companies targeting lower incomes. Consumers feeling the pinch might view upfront investments in Breville’s products – coffee machines, ovens and juicers – as saving money in the long run. And consumers already with appliances and needing new ones won’t put off purchasing a new one for too long.
Fourth, we observe that Breville has not had the same supply chain issues other companies have had. Unlike Kogan (ASX:KGN), Breville did not over-invest in new inventories predicting the boom would go on indefinitely. Still, Breville has not been and is not immune. In the US, it has encountered shipping delays in the Los Angeles port delaying the delivery of its goods to US consumers. The company therefore ‘stocked up’ for 1HY23 with the hope of minimising delays as we noted above. Although this met demand and did not leave a glut of inventory, Breville had to enter a net debt position to do this, as we noted above.
One of the best consumer discretionary companies out there
We are bullish on consumer discretionary stocks that have only been sold down due to fears that they will suffer from inflation when in reality there is little to no impact. Breville is one of the best companies in this regard, in our view.
Ideally, we buy this stock towards the lower end of the current trading range.
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