11min read
PREVIOUS ARTICLE A Climate Dividend for Austral... NEXT ARTICLE Australian Companies Outlook o...

I fondly recall buying baby goods (or watching my wife buy them) before the birth of our children. Like many expectant parents, we bought new rather than used baby goods, sought advice from a specialist retailer and later regretted buying too much.
The pricey baby-heart monitor seemed like a good idea at the time, but was never used. And a trendy pram often made way for a cheap stroller that was easy to get in the car. I remember thinking the baby-goods industry benefitted from irrational consumers such as me.
Things were simpler then (my kids are or almost teenagers now).  There was no dominant online retailer for baby goods at the turn of the century. No local Amazon distribution in Australia. And fewer online sites that recommended baby goods or sold second-hand ones. 
We bought our goods from Baby Bunting Group, Australia’s largest speciality retailer in this category. Baby Bunting listed on ASX in 2015 through a float at $1.40 a share. 
Investors could not get enough of Baby Bunting at the start. The shares more than doubled within a year of listing after the company beat prospectus forecasts. Strong comparable store growth and store openings drove rapid earnings growth and the market responded. 
Baby Bunting had several attractions. Parents were spending more on prams, cots, monitors and other baby products. Population growth was another tailwind for baby-goods retailers as more people meant more babies and higher spending on infant goods and services. 
Moreover, the baby-goods industry was, and still is, highly fragmented with lots of small operators that lacked scale. Baby Bunting’s scale was an advantage. 
High standards in the baby-goods industry appealed. Some baby-goods safety standards are unique to Australia, making it harder for international shopfront and online retailers to compete here. The standards created a barrier to entry to some international competitors.
Problems at Target and Big W were another plus for the baby-goods industry. The discount department stores, fierce competitors in cheaper baby goods, lost their way in this market. Target, once aimed at young mums and children, gave up this market position. 
Baby goods seemed more immune to the online retail threat. New parents wanted specialist advice on baby products and the in-store experience. Many excited, soon-to-be parents wanted to touch and feel cute baby products and enjoy the store visit, not buy online.
Baby Bunting built a compelling customer-value proposition: prices that matched the big department stores (or beat them), excellent advice and a larger product range. Like other successful “category killers”, customers loved its specialist focus.
Then reality struck. After peaking at $3.17 in mid-2016, Baby Bunting slumped to $1.27 in April 2018. Retail stocks were being hammered amid waning consumer sentiment, slowing sales growth and fears that Amazon’s expansion in Australia would crush the sector. 
Amazon is estimated to have more than 45 per cent of the market for online baby-goods products in the United States as time-poor, price-sensitive consumers favour cheaper products. Local investors feared Amazon would slash prices on a range of baby goods in Australia and take a chainsaw to Baby Bunting’s market share and dominance. 
A bigger problem was the closure of several smaller baby-goods rivals in Australia that were bleeding money or suffered from problems with their overseas parent.
Baby Bounce and Baby Savings – thought to be the third- and equal-fourth-largest firms in the local industry – and Bubs Baby Shops went into administration this year or last. Babies R Us closed in Australia this year as its US parent, Toys R Us, shut down. 
The collapse of several competitors should benefit industry incumbents in the medium term. But in the short term, it led to a fire-sale of baby goods and heavy price discounting. Irrational industry behaviour hurt the industry and its leader, Baby Bunting. 
The company issued three profit warnings in a little over a year and lowered its full-year earnings forecast as distressed trading from failed rivals crunched its sales and profit margins. The market took a blowtorch to Baby Bunting’s share price. The glamour stock badly lost favour.
Investors with a long-term view could see the value. Baby Bunting, a high-quality operator, has fewer competitors, Amazon’s expansion in Australia has been more muted than expected and most discount and department stores continue to struggle. 
Baby Bunting in August beat market expectations with its FY18 result, gave a healthy trading update and upgraded profit guidance. A recovery in the company’s gross margins, as excess price discounting from failed rivals worked through the industry, led the news. 
The shares raced from $1.40 to $2.41 and have since eased to $2.13 amid a falling sharemarket. Don’t be surprised if Baby Bunting eases further in the next few months after its rally and because of overall sharemarket weakness. That could be an opportunity.
Two critical long-term drivers for Baby Bunting – online sales and private labels – are growing quickly. Online sales rose 63 per cent in FY18 over a year earlier, off a low base, representing almost 10 per cent of total sales. Baby Bunting needs to build a much larger online presence to compete against Amazon, which will be a formidable rival in local baby-goods sales.
Baby Bunting’s private-label sales are on track to exceed 25 per cent of total sales in FY19.  These sales have higher profit margins and private labels help Baby Bunting reach price-conscious consumers who might have chosen discount stores instead. Baby Bunting wants its private- and exclusive-label sales to exceed 50 per cent of total sales. Private labels accounted for only 7.5 per cent of sales in FY15.
Store growth is another earnings driver. The company’s network of 50 stores in FY18 has doubled in five years. Baby Bunting believes Australia can support 80 stores.
At $2.13, Baby Bunting is on a trailing Price Earnings (PE) ratio of 23 times. That’s high for a micro-cap retailer but not excessive given its growth profile and market position. 
A handful of broking firms that cover the stock (too small a sample to rely on) have an average share-price target of $2.63, suggesting the stock is undervalued at the current price.
I’m not as bullish, but like Baby Bunting’s prospects for medium-term growth in online and private-label sales, and store openings. Industry conditions are tough and likely to get tougher as Amazon ramps up its local presence in baby goods. But Baby Bunting has room to grow organically as more Australians buy more baby goods instore and online.
Chart 1: Baby Bunting GroupSource: The Bull

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week’s newsletter

 

• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at November 21, 2018.