I’ve followed Breville Group (ASX: BRG) – which makes and markets home appliances such as coffee makers – for a long time. And I’ve always been impressed by the firm’s management, approach and execution. With the current share price around 40 per cent off its highs, and the company trading on a retailer-type price to earnings (P/E) ratio, I think there’s an opportunity for investors to buy this quality business at an attractive price.
In November 2012, for the then-in-circulation magazine Money, and with a share price of $2.84, we pointed to the significant cash generation, the history of intrinsic value growth and the company’s transformation from a manufacturer to an industrial design shop and brand marketer.
In 2013, we reported on the company’s partnership with Nespresso to produce a range of co-branded coffee machines. And in 2019, we included Breville in a list of companies whose futures were not dependent on the economic pulse of the day to deliver on their value-creation strategies.
Most recently, in February of this year, we pointed to Breville’s positioning to take advantage of the rapid premiumisation of in-home coffee making in the U.S., a valuation of just over $20, and noted the retail P/E multiple the stock was trading on despite it having none of the contingent liabilities or overheads of a retail operation.
Back in August 2021, after a huge pandemic-inspired rally, Breville’s shares hit $33.14. They have since declined approximately 40 per cent to the current price of $20.19 – bang on my recent estimate of the company’s intrinsic value, using a discount rate of eight per cent.
Interestingly, consumer discretionary stocks have been the best-performing sector since the beginning of the year, despite concerns about the impact of higher rates on consumers and the mortgage cliff confronting them.
That probably explains why Breville ranks in the top ten of small industrial companies most shorted. In early March, Breville had seven per cent of its stock shorted.
One broker noted discretionary consumer stocks have collectively risen 12 per cent, vastly outpacing the ASX200, which is up just under three per cent. While that might explain a thesis for the short positions, the same broker noted, “Investors are now circling back and picking up some of the worst-performing sector constituents on a year-rolling basis”, including Breville.
Of course, we don’t believe investors should pin their hats on any strategy that relies on other investors piling into something that has hitherto underperformed. Instead, investors should focus on the fundamentals of a quality business and its long-term prospects for earnings growth.
Breville shines on that front. It’s an innovative high return-on-capital business that continues to build its brand, extending it into new territories while deepening its new product pipeline through judicious research and development.
Much like the bear thesis for ARB Corporation, some of the investors shorting Breville point to a reversal of the tailwinds it enjoyed during COVID. Meanwhile, consumers with less disposable income are expected to trade down to lower-margin appliances. The evidence that this would impact Breville, however, is somewhat anecdotal and the bearish thesis largely reliant on macroeconomic observations.
Those with a negative bias also note the slowing stock turnover and destocking in Europe, which could put pressure on gross margins, as well as competitive pricing (something I believe is ever-present).
One broker has helpfully noted there may be some read-through from the results announcements of Newell Brands – the owner of Sunbeam appliances – on 28 April, and that of coffee machine maker De Longhi on 11 May.
And while we note the company appears to be trading on a retailer-type P/E ratio, which is undeserved given its lighter capital intensity, others compare Breville’s enterprise value (EV)/ earnings before interest, taxes, depreciation & amortization (EBITDA) of 14 times to overseas peers at just nine times, despite those overseas peers enjoying higher expected three-year earnings per share growth rates.
Of course, the bears could be right. If Breville’s share price falls, however, all things being equal, the discount to my estimate of its intrinsic value, would make the opportunity more attractive.
The Montgomery Small Companies Fund own shares in Breville. This article was prepared 13 April 2023 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Breville you should seek financial advice.
