Baby Bunting Group Limited (BBN) Earnings Call Transcript & Summary

Thank you all for standing by, and welcome to the Baby Bunting Group Limited FY '21 results. [Operator Instructions] I'd now like to hand the conference over to your first speaker, Mr. Matt Spencer. Thank you. Please go ahead.

Thank you, Tara, and good morning, everyone, and welcome to the Baby Bunting's results presentation for the full year ended 27 June 2021. Joining me on the call today is Darin Hoekman, our Chief Financial Officer, and good morning to you, Darin.

Good morning, everyone.

Before we begin, I'd like to acknowledge the traditional owners of the land upon which we meet today, and we pay our respects to the elders past, present and emerging. As Tara said, we will be taking questions at the end of the presentation. If we turn to Slide 4, our financial highlights. We present the numbers on this page on a pro forma basis. Our long-term goal has been to achieve an EBITDA margin of 10% of sales on a pre-AASB 16 lease accounting basis. I am extremely proud to say that we achieved this in the second half of FY '21. I am delighted by the performance of the business, and I'd like to take the opportunity to thank and acknowledge all the members of the Baby Bunting team who have contributed to this result in what can only be described as a very difficult and unsettling trading period. Thank you all. Sales of $468 million, a growth of 15.6% in the prior year, reflects the strength of our brand and the preference of shoppers to shop with Baby Bunting. Comparable or store -- same-store sales growth for the period of 11.3% was outstanding. In fact, on a 2-year basis, we have grown sales by 29.2% or $106 million, and this is reflected in the return on invested capital of our mature stores, which is now, on average, greater than 100%. Mature stores or stores over 4 years old are, on average, doing $8.2 million in sales with a store EBITDA margin of around 19%. Online sales of $91 million were up 54.2%, making up 19.4% of sales for the year. Interestingly, click and collect sales grew 110% for the period and now make up 57% of all online sales where Baby Bunting has a store presence. We continue to see gross margin improvement, up 83 basis points to 37.1%. This has been achieved while still ensuring that we offer great value to the consumer every day and every visit, backed by a 5% price beat guarantee. Contributing to the gross margin expansion has been the building of our private label brands and exclusive brands and products. This differentiated product now makes up 41.4% of sales. We have also made significant headway on our supply chain strategy, which all adds to our gross margin improvement. We have achieved cost of doing business leverage, impressively 94 basis points at a store level. Of note is our labor sales rate improvement in-store and the weighting of marketing spend away from traditional medium such as printed catalogs. This is now trending down to the extent that on a year-on-year basis for the last promotion, it's down 50% in number, with a switch to a greater investment in digital mediums. Overhead costs included around $2.2 million relating to COVID expenses and expenses relating to a biosecurity event response. There has also been a significant investment in capability within the organization across IT, cybersecurity, digital, supply chain and operations. In summary, sales up, gross profit up and cost of doing business leverage achieved, resulting in a pro forma EBITDA uplift of 29.2% to $43.5 million and a pro forma NPAT growth of 34.8% to $26 million, EPS growth of 33.2% and a full year dividend of $0.141 per share, the result of an $0.083 final dividend, an extremely pleasing set of numbers achieved in difficult times. If we just turn to Slide 5, please, our operating highlights. Our #1 focus in the business is to keep our teams and our customers safe. I'm pleased to say that we've continued to progress this with further improvements in our safety performance. Throughout FY '21, all our stores have remained open as we provide essential goods and services to parents-to-be and new parents. Sales patterns do get affected during lockdown periods. As a business, during this difficult trading period, we did not receive any JobKeeper payments and nor did we receive any rent relief from landlords. We continue to grow our private label and exclusive brands and products, which now make up 41.4% of sales. It was tremendously exciting to launch our private label hardgoods brand, JENGO, which has performed very, very well. We're also excited to announce our exclusive access to the Steelcraft, Baby Love and Joie brands. Steelcraft, in particular, is a well-known trusted Australian household brand that has served and supported the needs of parents for over 50 years. These brands deliver differentiation and gross margin benefits and were previously sold through many other retailers. We have a store network plan of over 100 stores in Australia, and through the year, we opened 4 new stores to end the year with 60 stores. We opened between 4 and 8 stores per year, and for the year ahead, we have a strong pipeline of new store opportunities. We continue to sell from our website to New Zealand and have recently launched babybunting.co.nz, employing our headless architecture, the forerunner to the Australian website being launched later this half. We have a store network plan for 10-plus stores in New Zealand. While the project is progressing well in terms of consumer offer, supplier discussions and resource planning, the securing of property and the opening of new stores is delayed largely due to the impact of COVID and our inability to spend time in the market. At this stage, it is more likely that our first physical store will be opened in Q4 FY '22. We will continue to grow our digital footprint and representation online ahead of physical stores opening. A key element of our strategy to grow market share is through our investment in digital. This encompasses the improvement of our customer experience online. We have a long-term ambition of being able to leverage our store network to fulfill 90% of online orders in metro areas same day. In this respect, we have continued to grow significantly. For the full year, around 41% of online orders have been processed through our store network. Digital investment and the move to a headless online architecture is part of our broader transformation program. This will lay the platform for long-term sustainable growth. I'll elaborate a little further, but I'm pleased to say that despite substantial impacts as a result of COVID-19, we have made significant inroads this year to our transformation agenda. Another key part of the transformation program is our supply chain strategy. And in the second half, we moved into a new 22,000-square-meter distribution center and co-located store support office. This project has enabled us to streamline our storage and handling costs by removing the need for 2 additional 3PL warehouses in Melbourne. The new DC has also facilitated a 60% increase in container volume and supported our private label and exclusive products strategy. The business has certainly developed, and we have progressed our environmental, social and governance or ESG agenda through the development of our ESG road map. This road map focuses on our people, our community where we operate and our environmental impact. Our plan is to release our first sustainability report later this year. If you could please turn to Slide 6. What brings me great pride and confidence in our future market share growth is the way we have grown as a brand and the great relationships we enjoy with our customers. Our core purpose is to support new and expected parents in their parenting journey, and we do this in many ways, in particular through our multichannel approach to providing customer support they need at a very special time in their lives. Since 2015, we've been tracking our brand health every 2 years through an independent survey of mothers at various stages of early parenthood and gift givers. What we have seen over time is the growth and recognition of Baby Bunting brand and the preference of new and expected parents who say Baby Bunting is their preferred physical store to shop. We track a number of measures, but most pleasing is that virtually 9 out of 10 people recall with no prompting that Baby Bunting is a place to shop for essential products, such as car seats, prams and nursery furniture. 71% of people surveyed who have shopped for these types of products rate us as their preferred physical store to shop. In our store surveys -- sorry, in our surveys, these numbers are far superior to any other retailers who stock Baby Bunting products or baby products. Having such a great brand awareness provides us with great confidence when we have plans to roll out new stores into new catchments, reinforcing our vision of being the most sought baby retailer for every family, everywhere. With around 300,000 births per year, our loyalty program plays a significant role in customer retention and frequency of visit across all channels. We have around 1.1 million loyalty members, of which around 600,000 have been active in the last 12 months. What we do see is that our customers have a higher frequency to visit and spend in the early part of their journey, being pregnancy through 12 months of age. Our customers then reengage with us when they reach the next milestone, such as toilet training or moving from a convertible car seat to a forward-facing car seat or when a subsequent child comes along. This customer life cycle management through our loyalty program is significant, and I've been delighted by the success of the Phase 1 launch of our new loyalty program called Baby Bunting family. I'll elaborate further. If you can please turn to Slide 7. We launched Baby Bunting family, our new loyalty program, early in the financial year, and we've seen some really promising results. To date, the conversion rate from non-loyalty members to becoming a loyalty member is extraordinarily high. And this is translated into around an additional 25,000 new Baby Bunting family members per month. Impressively, on average, loyalty members are spending around 36% more per transaction than non-loyalty members through their higher item -- average item values and increased average items per transaction. Leveraging our marketing automation tools, we have around about 90 customer journeys we can personalize that keeps customer engagement levels high. We are now looking forward to the launch of Phase 2 of the loyalty program, which will go live with our new website and will leverage our headless digital architecture. This phase is expected to transform the program, delivering greater benefits and rewards to those members who shop with us. Phase 2 will also unlock greater personalization and will be omnichannel in design, supported by a new loyalty management system. This transformation program is expected to be implemented in the first half of the financial year. I'd like to now provide you with a brief summary of where we're at in the transformational agenda on Slide 8. Our transformation program has continued through the year. And although there has been some impact to timing as a result of COVID-19, our transformation program is a series of significant one-off large-scale investments that will underpin future growth. We're well progressed with the program work. Over the past year, we have seen a number of these transformation projects completed. As highlighted, COVID-19 has impacted our transformation agenda, and I'd like to give a brief summary of other areas affected by the COVID-19 pandemic. If we could turn to Slide 9. The essential nature of the products we supply and the customers we service with around 6,000 births per week meant that all our stores remained open throughout the year despite the challenges associated with many lockdowns experienced across the nation. Our priority is the health and well-being of our teams and our customers, and our large-format destination stores has meant that we can operate safely, providing our customers a safe place to shop for their essential needs. To support our team, we have introduced the following: 2 weeks paid COVID leave; appreciation leave to say thank you for going above and beyond and the great efforts by our team; 8-hour vaccination leave to support the national vaccination effort; and to complement this, we've also provided financial gifts to all team members in recognition of the efforts in a difficult period and a chance to enter into a draw for $10,000 worth of prizes for our team members who are fully vaccinated by the end of November. COVID lockdowns, in which there have been 15 across the country, do impact the flow of sales. Given the less discretionary nature of our category, we have seen historically that sales are not lost but are deferred until they become absolutely essential, when a customer is in the final trimester of the pregnancy or when they have just had the baby and the requirements post birth become a necessity, for example, breast pumps or feeding aids, sleeping aids or car seats and capsules. We have communicated all the different ways for the consumer to shop with Baby Bunting. However, the predominant response has been to shop in-store for essential items where customers can get the appropriate service and tailored advice for their needs. Our stores are also the place customers come to get their car seats fitted. In the last year alone, we have fitted over 130,000 car seats for our customers, just another example of the importance of our stores being opened. Our financials, which Darin will talk to in a moment, reflect the fact that we did not receive any JobKeeper support nor did we receive any rental support from our landlords, and the cost of doing business includes around $1.1 million in COVID-related expenses. I might pause here to hand over to Darin, who will run through the FY '21 financial results in more detail. Thanks, Darin.

Thanks, Matt. If I can get everyone to turn to Slide 17, the profit and loss statement. We are presenting the income statement on a pro forma basis to clearly demonstrate the underlying trading performance of the business. There is a reconciliation explaining the differences between the pro forma profit and the statutory profit on Slide 26 of this presentation and also in the annual report. But in summary, the current and prior year differences relate to the exclusion of employee equity expenses, significant business transformation project costs and the $2.4 million payment received from a former digital technology vendor. The key callouts for profit performance are again sales, 15.6% sales growth driven by 11.3% comp store sales growth, 4 new stores and annualizing stores opened last year; gross margin, 83 basis point increase in gross margin delivered year-on-year with 119 basis points in the second half and 41 in the first half; retail costs, a 94 basis point improvement in our retail cost to sales ratio and overhead -- investment in our overhead cost base to support future growth. It is worth emphasizing here that as a business just over halfway through its network rollout, we will continue to invest in our cost base over time and ahead of the growth curve. Our overheads were impacted by 3 items in FY '21 that warrant calling out. The first is the $1.1 million of biosecurity costs that we incurred in the first half. The total cost to manage the biosecurity event was $2.2 million. But at this stage, $1.1 million of those costs will be covered by our insurance and sit as a receivable in our balance sheet. The remaining $1.1 million sits within cost of doing business, and we do not expect these will reoccur going forward. The second callout is our COVID cost of $1.1 million. The majority of these costs were incurred in the first half and should reduce significantly going forward with some residual and ongoing minor costs pertaining to PP&E purchases and COVID leave for team members that may be forced to isolate. The final callout is that we accrued $2 million in staff incentive payments in FY '21 relative to 0 in the prior year. These are financial bonuses to reward our staff for the outstanding results they have delivered for the FY '21 financial year. To summarize earnings, EBITDA of $43.5 million was 29.2% up on the prior year, delivered with 100 basis point improvement in EBITDA margin from 8.3% up to 9.3%, noting EBITDA margin got to 10% in the second half. And finally, it was great to see the sales and margin gains flowing all the way down the P&L to deliver pro forma NPAT growth of 34.8% year-on-year. Slide 18. Looking to the balance sheet, we have again finished in net cash position despite the significant investments in transformation we are making on the business. The net cash position gives us significant headroom to further progress our transformation and growth agendas in the coming years. The primary callout on the balance sheet is the $15 million investment we made in our inventory, now $80 million. Of this, around $10 million is recovering our in-stock position from the prior year, which was depleted below our planned holding levels due to the extraordinary growth we saw in May and June 2020 after the initial national COVID lockdown in April 2020. In addition to recovering our base inventory position, we also added $3 million for the 4 new stores we opened and a further $2 million to maintain appropriate weeks-on-hand inventory relative to our higher sales profile. Looking forward, we will build our inventory levels further in the first half of FY '22, which is similar to the year just gone, where we held $92 million of inventory at the half. This will further mitigate risk in relation to potential COVID-related supply chain impacts and to ensure sufficient inventory coverage for post-Christmas sales and Chinese New Year shutdown. With capacity at our new DC and low financing costs, the benefits of protecting future sales outweigh the associated holding cost of higher inventory. You'll also note our right-of-use assets balance and the associated lease liabilities provisions have increased by around $20 million year-on-year. This is primarily due to the addition of our new DC where we have taken out a 12-year lease. Moving now to the cash flow statement on Slide 19. We had free cash flow of $4 million, well down on the prior year of $23 million, which benefited from a significant short-term working capital benefit as we came out of lockdown in the prior year, which I just described when talking about the balance sheet. Our operating cash flows after this working capital investment were $22.8 million, of which we invested $18.8 million into our capital and transformation programs as well as paying out $15.7 million in dividends. Adding the $0.083 dividend we have announced today, along with the interim dividend of $0.058 paid back in March, we will pay out 70% of our pro forma NPAT to shareholders. Turning now to Slide 20, which presents our updated store economics slide. When we first presented this slide back in 2016, our average mature store return on invested capital metric was 70%. This is now above 100%, delivered through continued expansion of market share in the markets that we operate plus higher gross margins and strong management of our store cost base. Our mature store cohort is now up to 36 stores, 33 of those are metro and 3 regional. For our mature metro stores, 23 of the 33 are delivering over plus 100% return on invested capital, with the lowest being around 70%. Regarding our regional stores, of which there are 6 that have now completed more than 2 full years of trade, these stores are delivering capital returns of between 70% and up to 100%. Virtually all of our stores are performing incredibly well, with the one outlier probably being Chadstone, which after a sensational first year really felt the effects of the COVID lockdowns and shopping center avoidance more than any of our other stores. We are expecting this store, which is in a great location and has a terrific team, to recover quickly when we return to a more normalized trading environment notwithstanding all our other shopping center stores, of which we now have 4, show encouraging signs in their first year of trade, and we will continue to look for the right opportunity in these centers as well as our traditional large-format center locations. That concludes the financial update. So I will now hand back to you, Matt.

Thank you, Darin, and I'll reiterate a very pleasing set of numbers for the year. Turning to Slide 21. Speaking of looking ahead, we have -- I think apart from an exciting transformational agenda, including the new website and Phase 2 of the loyalty program, we also have some other exciting things ahead of us. We look to roll out new stores probably at the top end of our range of 4 to 8 with a number of leases already signed. We look forward to opening our first stores in New Zealand and continue to focus on margin improvement through the strengthening of our supply chain and logistics capability. We will continue with our focus on our private label and exclusive brands with the aim of this being 50% of sales in the medium term. And finally, we hope to see vaccination rates improve and see fewer lockdowns and disruption to our lives as a result of COVID-19. Slide 22. Over the page, we track the Medicare 12-week scan data, which is highlighting the potential uptick in births through the first half of FY '22, which I believe sets us up well given our high brand awareness and brand preference. Before talking about the outlook, I might take a moment to provide some detailed context about the impacts of lockdown on our business and the flow of sales. So turning to Slide 23. As highlighted, the baby goods category is essential and a nondiscretionary category. People who are having babies in the next few months are already well progressed in their pregnancy, and their needs are established. What may not have occurred as yet is the act of actually purchasing product. In lockdowns, we are mainly seeing those customers in our stores when the need becomes essential. It's important to emphasize that in our category, in-store service and tailored advice is critical. Things like checking a car seat's fit in a car or having it installed correctly in addition to these products on feeding a baby and mother's health and the technical items that need tailoring to the customers' needs. We also stock a range of items specifically focused on premature babies and parents of premature babies who are working through unexpected circumstances and need the help and guidance of in-store service. To help break this down a bit further, we have provided a table which highlights that consumers in the third trimester and those that have just given birth are actively purchasing products predominantly in-store when they can experience a product and get the service and advice they require. Customers in trimester 1 and 2 and gift givers are more likely researching online, purchasing online and deferring their store visits to post-lockdown or when the need becomes essential, as in the case of long lockdowns. It is our view and experience that these sales are not lost, they are deferred. The graphs below reflect the impact of comparable store sales when we have a 3-day lockdown, a 5-day lockdown, a medium-term lockdown of around 12 days and then a long lockdown. In all cases, we see comparable store sales recover quickly. This gives us confidence in relation to the current impact of lockdowns on our year-to-date sales performance. Now let's turn to the outlook on Slide 24. Year-to-date, comparable sales have been affected by lockdowns across most states and significantly Victoria and New South Wales. As at 12th August, comparable store sales were negative 6.4%, impacted by the current stay-at-home orders. I would remind you that this time last year, the only stores in lockdown were 12 Metro Melbourne stores, and comp store sales were running at around 20%. We've seen a recovery of comparable store sales during the period in line with expectations and historical lockdown trends. About 80% of trading year-to-date has been impacted by various state lockdowns. Online sales were up 32.6%, cycling 123% pcp. This period is our lowest sales period for the year, following our largest trading month of the year in June. And we're confident, based on historical sales performance and patterns post-lockdowns, that sales will recover. The Medicare 12-week scan data and the strength of our brand underpins our confidence in the future. We anticipate opening 3 stores in the first half with a strong pipeline of stores in the second half plus 2 stores in New Zealand. Given the uncertainty caused by the pandemic and consistent with last year, we're unable to provide guidance at this time. On behalf of Darin and myself, we'd like to thank you for your support and attendance today. We will now take any questions you may have. To assist, please state your name and who you represent. Thank you so much.

[Operator Instructions] Our first question comes from Jo Little at Morgans.

Can you hear me?

Yes, Jo.

Congratulations, guys, on another strong year of growth. Just a couple of questions. Just firstly on the DC. So that's all up and running. I think at the last result, you said you'd be in a better position to provide some clarity on the benefits we should expect. So just wondering, can you confirm the immediate benefit to the gross margin maybe in FY '22? I think from memory, you said around 20 basis points. And then perhaps some color beyond that now to were through that kind of project.

Yes. Jo, I'll take that one. Yes, that is correct from a margin perspective. That will flow in over time as we transition our direct-to-store vendors into fulfilling -- they'll be fulfilling direct into our DC. The other benefit that, that DC will give us is we'll be able to add additional stores and then leverage our -- leverage the cost base of that DC. In the FY '21 financial year, we did incur around $1 million worth of variable warehousing 3PL costs in Victoria to sort of hold the inventory because we just ran out of space in the DC. And so that will go away in the new financial year as well.

Okay. So not willing to kind of talk about the benefits longer term? Is it just too early, quantify, I mean?

We -- well, I think that -- I mean very quickly, we'll transition those suppliers through FY '22 from a margin perspective, and then we'll hold that maybe beyond that. Then you're looking at sort of leveraging because your variable costs, which were increasing as we're adding stores into the network, that won't be the case. And so we -- they'll be flat relative to the addition of new stores and additional inventory as we roll those stores out.

Okay. And it sounds like you're going to do about 8 stores this year or thereabouts. Where are they kind of located? I mean should we expect much cannibalization? Or are they in new markets?

It will be a blend of regional and metro. So there'll be 4 regional, 4 metro; 3 in the first half, of which 1 will be in Metro Sydney. And then in the second half, it will be 3 and 1, so the reverse -- so 3 and 2, so 3 metro and 2 regionals. And then [ from over here, ] okay.

And just New Zealand, obviously, you said -- when you initially flagged the 4 stores, you said obviously, we're assuming we can get over there and travel, which has not been the case, so 2 in the back end of the next financial year. I think we kind of, on the last conference call, talked about kind of modest losses from that region. Would that still be intact, Darin?

Yes. We're still investing in standing the business up. And so there'll be cost of around $1.5 million to actually get the business stood up. Then what was -- what we're anticipating occurring was as we roll out, which we're planning to roll out 4 stores in FY '22, that the margin and the profit from those stores would defray those, opening those sort of standup costs. Obviously, that will be lower now that we're having to defer the opening of the stores.

Yes. Understood. And sorry, just lastly, great to see that mature store margin up at 19%. I guess the next question is, is 12% a new long-term EBITDA margin if we assume that your overhead as percentage of sales is about right?

I think that looking ahead, we see more opportunities for margin growth, and we see opportunities for -- to deliver efficiency gains. That's what our transformation agenda is all about. And we know that there are things that we could do more efficiently today. And so we've got our eye on sort of driving those costs out of the business. And also, we see sort of more opportunities in the supply chain and sort of getting those costs down, which will help our margin over the long term, growing our market share and absolutely growing our market share, which will also sort of help deliver leverage through the overhead base.

Our next question comes from Marni Lysaght at Macquarie Capital.

My question is just around -- I understand the gross margin improvement that has been recorded and particularly, that's the second half as a result of various initiatives. But is there any -- I mean are you seeing any kind of cost inflation coming through particularly from the likes of logistics? And are you confident that, I guess, the move to private label and other initiatives will help you offset that?

The second half included -- so our international freight rates did increase. And we saw that kept aside the margin that you see in the second half, which was up over 110 basis points in the second half, includes the increased international freight costs. It also includes the addition -- so very late in FY '20, we added our 5% price beat, and that's actually had a decreased 15 basis point margin on the result in both the first half and the second half. And so you're actually seeing a very strong gross margin performance when you cast in that -- in light of those 2 downward elements, too.

Okay. And have you seen any other changes in say the part of early -- since the end of the 30th of June, any other changes coming through in that? And you're quite confident that the initiatives that you have underway will continue to offset that?

The -- well, as I sort of pointed out to Jo, there's plenty of initiatives that we got coming out of the pipeline. I mean from an FOB perspective, I mean it's still the smaller proportion of our cost of goods sales base. And so around 15% of our purchases are in U.S. dollars. So it's still not a significant component of our -- the profile of our sales. So we are confident that we can continue to grow our gross margin...

No. That fine.

Notwithstanding...

Are you there?

I was just going to say notwithstanding that. I mean I think we're facing the same challenges as everybody else with regards to the international freight, but we've got contracted rates locked in at the moment.

Our next question comes from Tim Lawson at Macquarie.

Just on Slide 8, you provided a good profile of CapEx and OpEx out FY '22 and '23. But just the profile of that, you've got sort of OpEx slowing initially and then accelerating again. Can you just talk through the various initiatives there, what the investment is?

Well, what we've got coming up is we're finalizing the Australian digital architecture. It's occurring. Then in addition to that, we've got people systems occurring. We're bringing in an advanced order management system. We're standing up the second phase of our loyalty program. We'll commence work on ERP, point of sale and a number of other elements. I mean when we sort of originally forecast out this program, we had estimates around CapEx and OpEx. But that evolves over time. And because the majority of the systems that we are introducing is Software as a Service, what you find is the standup costs of these systems are actually items of OpEx as opposed to CapEx.

And so there's nothing to [ write about ]...

So I think...

That will [ explain ] CapEx trend margin should improve more strongly from CapEx versus OpEx or vice versa?

These are -- so we had a defined transformation agenda, Tim, which you see on that page. And so all of these items, those OpEx items will be pro forma out of our results. And that is because they are not operating costs. They are costs associated with the establishment of all of these systems that you cannot capitalize under accounting standards. Going forward once these systems are introduced, for example in FY '22, we'll see -- we'll have annual OpEx cost in relation to our people systems of around $300,000 per annum, which is the licensing to run that and also the -- maintaining that. The capital costs and the OpEx costs are actually one-off operating costs to stand net to this amount in the first instances, a lot more than that, but then they do have ongoing costs. It's like renting a store.

Our next question comes from Sam Teeger at Citi.