Breville (ASX:BRG) the kitchen appliance company this week reported another record for half-yearly sales, albeit slightly below consensus. First half 2023 revenue grew 1.1 per cent to A$888.0 million, which was also 0.7 per cent higher, on a constant currency basis, than the first half of FY22.
Breaking the sale revenue result down geographically, The Americas were up 11.9 per cent (well above market rates of growth which we highlight below), Europe, Middle East, and Africa (EMEA) were down 19.6 per cent, and Asia Pacific (APAC) was virtually flat, at up 0.4 per cent.
Underlying EBIT of $121.1 million beat consensus and was 7.6 per cent higher than for the first half of 2022. The company’s EBIT margin also beat the prior corresponding period, coming in at 13.6 per cent versus 12.8 per cent. Net profit after tax of $78.7 million was 1.3 per cent higher than the prior corresponding period.
As we also noted in JB Hi-Fi and Nick Scali’s releases, gross margins for Breville have improved to 37 per cent versus 36.3 per cent for the six months ended December 31, 2021. But there was important information in the detail. The company was able to put through price increases which helped to offset adverse currency movements and higher freight costs.
Some analysts might see this is a negative – had the company not been able to pass through price increases, its gross margins would have suffered. But the ability to pass on price increases is arguably the most valuable competitive advantage. And freight costs are now declining, and currencies, particularly the US Dollar, are moving favourably (downwards) against Breville’s main trading currencies.
Noting the company will release working capital in the second half of 2023, and assuming relative stability in the economies in which it operates, Breville expects full-year EBIT to be between $165 million – $172 million, which compares to the current consensus of about $170 million.
Regarding regional trading updates, the results did not highlight any major changes from the picture offered at the AGM last year; Trading in America remains strong, APAC is still steady, and Europe remains weak.
Analyst concerns
For some analysts, the fact consumers are moderating their spending in Australia, and the U.S. while Europe’s economy continues to splutter predicts a challenging period ahead. Their view is that declining volumes may more than offset the strength in margins from recent price increases and new product launches.
Analysts also point to the increase in net debt – from a net cash position in the prior corresponding half of $32 million to a net debt position of $212 million (due primarily to inventory investment and the acquisition of Italian specialty coffee group Lelit) – combined with rising interest rates, as increasing risk and earnings per share.
Elsewhere, inventory also grew by more than analysts expected from $293 million in the half-year ending December 21, to $465.2 million in the most recent half.
Breville explains that obsolescence risk is “negligible” for their products, so the company holds incremental inventory as a “hedge against supply chain uncertainties and ongoing demand fluctuations”. Each year Breville lands inventory to support the maximum forecast sales for the peak season. They subsequently adjust purchases in the second half to bring each product back to equilibrium. While the company noted, “With supply chain uncertainties now abating, we are transitioning back to our normal inventory flow model, which should see reduced inventory”, another reading might say they’ve overstocked. The company noted it is not expecting a repeat of the build.
Of the $172 million increase in inventory, the company noted $66 million was due to the ‘planning approach’ referenced above, $106 million support future revenue growth streams, $73 million relates to the addition of Lelit – as well as new geographies (Mexico and South Korea) – and $33 million relates to inventory held for new product launches.
Finally, the company’s ROE has dropped as a consequence of its acquisition of Lelit and the associated capital raising of $56 million. On a consecutive rolling 12-month basis, ROE has fallen to 16.1 per cent, from 19.7 per cent for the 12 months ended December 31, 2021.
The positives
Breville is a company with several sources of growth and the potential for a rerating. First, and perhaps most obviously, is geographic expansion, including but not limited to South Korea and Mexico.
Secondly, during the COVID pandemic the company continued to research and develop new products but were unable to release them. The company refers to this indirectly in its comments about inventory. The resultant pipeline of new products could mean an acceleration in product releases and consequent sales in coming periods.
Finally, the U.S. market. The America’s represented 58 per cent of the company’s revenue in the most recent half and grew 11.9 per cent. In constant currency terms, the Americas revenue has grown by 16 per cent per annum over the last six years. We currently expect strong growth to continue for two reasons. The first is the massive shift – thanks to cooking shows on Netflix – from brewed coffee to real coffee. The U.S. is an immature market when it comes to real coffee and George Clooney has played no small part in alerting Americans to their unsophisticated coffee preferences.
According to the U.S. National Coffee Association, coffee consumption soared to a two-decade high last year, and 66 per cent of Americans now drink coffee daily. This is more than any other beverage, including tap water and is up by nearly 14 per cent since January 2021.
More importantly, specialty coffee consumption hit a five-year high with 43 per cent of coffee drinkers choosing specialty coffee in the past day, up 20 per cent since January 2021.
But most importantly, the National Coffee Association noted, 41 per cent of coffee drinkers use a drip coffee maker (Arghhh!). Only eight per cent use an espresso machine, suggesting there is a very long runway of growth ahead for Breville.
In addition to the long runway of growth for Breville’s coffee business, U.S. demand for Breville’s air fryers and smart ovens is exploding thanks to the trend for healthier eating and chef-guided cooking at home, respectively.
The premiumisation of home cooking and coffee making means Breville’s products can be priced acceptably, if not affordably, for the affluent consumer. These consumers are less sensitive to interest rates and economic conditions. Meanwhile, Breville doesn’t require external capital to continue deepening and lengthening its pipeline of new products, a source of continuing double-digit EBIT growth.
Is Breville good value?
Breville’s share price rallied almost 160 per cent during the Covid-19 pandemic as investors jumped on the work-from-home and create-the-perfect-bunker themes. As economies reopened, however, those share gains unwound, reinforcing Breville’s apparent status as a COVID-19 beneficiary. Investors will need some time to accept they might have this company wrong.
Breville is more than a Covid beneficiary. And Breville is not a retailer. It owns brands and IP, and manufacturers superior and desirable products that are sold to retailers at pre-defined margins. Its major market is growing at double-digit rates and the runway for growth is long. Meanwhile, Breville’s customers are less economically sensitive. It is arguable Breville should be on a higher than retailer PE ratio.
Assuming a discount rate of eight per cent, a sustainable return on equity (ROE) of 17.5 per cent, end-of-year shareholder’s equity of $760m, a payout ratio of 38 per cent, and 143 million shares on issue, we obtain a valuation of $20.20. The shares currently trade just above $20 but that’s on a retailer-type P/E multiple.
The Montgomery Small Companies Fund own shares in Breville. This article was prepared 16 February 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