Less Robusta

UPDATE

Need To Know

• Weak European sales in 2H22 a pointer to broader sales slowdown
• Consensus valuation metrics too high
• Balance sheet is very strong

Breville has successfully transformed its products from being ordinary household bench-hoggers and cupboard fillers to smart appliances that give consumers a sense of luxury and comfort.

Geographic growth. BRG has expanded its reach across Europe and the Middle East (EMEA) under the Sage brand which is being supplied from the UK warehouse. The unification is having a positive impact on distributor revenue. EMEA sales increased 38.5% in 1H22 but the Ukraine invasion caused 2H22 sales to fall by 15.9% (FY22 +15.1% CC). BRG has entered Poland and South Korea as new markets.

Americas sales now account for just over half of group sales. FY22 sales growth of 19.4% (CC). It was the fastest growth region for BRG at 32% on a reported basis, or 24% in constant currency terms.

Inventory strategy. BRG has taken a conscious decision to avoid potential supply chain issues for 1H23f sales by lifting its inventory levels higher than usual. Working capital as a percentage of sales has therefore increased materially from 13.5% in FY21 to 24.5% in FY22. BRG is prepared to wear this risk because it does not discount excess inventory but does not want to run short of stock. The strong constant currency sales growth rates in each geographic segment suggests the confidence in sell-through is well-founded, although we note the 2H22 softness in Europe due to the Ukraine situation. This strategy is at least partly informed by the company’s experience in FY21 when working capital was below ‘equilibrium’ with insufficient landed inventory resulting in constrained revenue and unusually low receivables.

New products. A related issue to the inventory strategy is BRG’s relentless pursuit of new products. A theme emerging in the last year or so is towards making ‘old’ appliances smarter by adding mobile apps to control them and to access professional advice on how best to use them (ChefSteps). BRG calls this ‘Solution Thinking’ and considers not only the product but the software and services that can enhance it. Acquisitions such as Baratza have provided adjacent products such as single brew coffee grinders and instant hot water dispensers. BRG recently completed the acquisition of Italian premium espresso coffee machine maker, LELIT ($140 million) to complement its own portfolio.

Investment view

The premiumisation of coffee, particularly for in-home use, has been a catalyst for BRG’s impressive long term growth. Clever design based on extensive research and development has put Breville products into the ‘must-have’ category for many consumers. This has been the key factor in the compound annual growth rates (CAGR) of 18.5% and 15.9% per annum for sales and EPS over the last five years.

Consensus earnings forecasts are still baking in 11.5% EPS CAGR over the next three years, but this is looking optimistic in the current environment, in our view.

Earnings softness in 2H22 was attributed to the disruption from the Ukraine situation, but we think sales weakness could become much more widespread as FY23f unfolds. In Australia, consumer sentiment as measured by the Westpac/Melbourne survey, remains quite negative (Index 84.4 is 16% below average) and is historically consistent with consumption growth turning negative year-on-year, indicating a slowdown in sales is on the way. This contrasts with current anecdotal retail sales evidence and although we expect the Annual General Meeting season to contain positive trading news generally, this will be the tail end of a post-COVID spending catch-up.

BRG’s balance sheet is undeniably strong, even with an elevated inventory position, so this will provide a cushion through a weaker sales period. We acknowledge BRG’s preference to avoid discounting to clear inventory, but this remains an issue to be monitored.

Risks To Investment View

Consumer spending and sentiment may change as interest rates and inflation increase. BRG’s products are discretionary so sales and earnings are dependent on household budgets. BRG is exposed to currency movements given its global distribution model. Competition and technology changes could affect sales.

Recommendation

We have retained our Hold recommendation, balancing our view of an expected decline in sales growth rates with a strong financial position.

This commentary reflects our initial view. For detailed reports for companies under Sandstone Insights coverage, see our latest research notes for our investment view and specific risks associated with investing in these companies.

FIGURE 1: FY22 RESULT

FIGURE 2: BRG REVENUE

FIGURE 3: INVENTORY AND GROSS MARGIN

FIGURE 4: NET DEBT/(CASH)