Another high quality result - Breville

Breville Group (ASX:BRG) is a company owned in the Montgomery Small Companies Fund and one we have written about extensively. Back on April 14, I wrote about Breville, its 40 per cent share price decline from August 2021 highs and the fact that it was trading on a price earnings (P/E) ratio typically reserved for retailers with store lease obligations and few runways for growth.

I wrote at the time, “With the current share price around 40 per cent off its highs, and the company trading on a retailer-type price to earnings ratio, I think there’s an opportunity for investors to buy this quality business at an attractive price.”

Breville’s share price is up 25 per cent since that blog post, while the ASX200 is down 3.3 per cent and the Small Ordinaries (XSO) is down 4.1 per cent. As an aside you may also like to read our prescient blog post and view of Nick Scali, with the share price up 38 per cent in an otherwise flat market since that post was published.

The reason for linking those two companies is that we regard them as objectively very high-quality businesses run by excellent management teams.

A substantial reason for the impressive performance of Breville’s shares, since April 14 however, is a 10 per cent move up following the announcement of its full year results this week.

It was indeed a solid result for 2023, with revenue growing by 4.2 per cent, two per cent above consensus and earnings before interest and tax (EBIT) at the top end of guidance having grown 10 per cent. Gross profit grew 6.4 per cent (with 10.6 per cent growth in the second half). Gross margin strengthened thanks to a recovery of cost inflation through price rises and by controlling promotion activity.

The company noted, “We delivered +10.0 per cent EBIT growth by leaning into our company-specific growth levers, preserving our gross margins, and thoughtfully managing operating expenses (OPEX)”. Both Gross Margin and EBIT margin improved, and note the Gross Margin improved despite inflationary pressures on inputs (one of the most valuable competitive advantages is the ability to raise prices without a detrimental impact on unit sales volumes). Net profit after tax (NPAT) also grew by 4.2 per cent and would have been higher if not for higher borrowing costs.

Keep in mind these results are in the context of a weak consumer backdrop.

All divisions and geographies experienced encouraging performance. Asia-pacific (APAC) revenues were up 4.3 per cent, beating consensus estimates by four per cent, Europe, Middle East, Africa (EMEA) was down 3.1 per cent on last year but 1.5 per cent better than consensus and the all-important U.S. market was in line with expectations growing seven per cent.

The company experienced an acceleration in revenue growth in the second half of the financial year rising by close to 10 per cent. This was led by EMEA, the numbers also benefitting from a poor prior corresponding period.

The company did not offer numerical guidance, citing uncertainty and listing headwinds and tailwinds in a presentation to analysts following the result. The headwinds included inflation (logistics, software, utilities and input costs), increasing interest rates, cost-of-living pressures, the on-going Ukraine war’s, impact on Europe and unpredictable retailer and competitor behaviour.

On the plus side the company cited strong employment globally, a solid pipeline of new products, price increases, declining logistics and shipping costs, broadening geographic reach, the launch of a limited range of products into 1000 U.S. Target stores, and improving U.S. brand recognition as evidenced by products selling out during Amazon Prime’s Prime Day in July. The addition of manufacturing of coffee machines in Mexico will mean a shorter supply chain for U.S.-bound product and the avoidance of the Trump China tariff.

Perhaps most importantly, the company reaffirmed our thesis that the trend toward more sophisticated coffee drinking at home in the U.S. is structurally underway. The company added Airfrying to the same theme, however your author fears this is more of a fad than a structural shift in the way the world cooks and prepares food.

As the company had previously indicated it would, inventory declined to $440 million, core inventory declined by 22 per cent or $97 million in FY23.

Return on Equity (ROE) (I delight in companies that call this measure out in their results presentations) fell to 15.9 per cent from 18.9 per cent and investors will have to track this number closely. Notably, net debt rose $117 million to $121 million due to the Lelit acquisition and working capital. Assuming no further, nor any over-priced, acquisitions, organic improvements to, and growth in, all businesses should help ROE recover.

Breville’s shares are now trading on an P/E multiple of 27 times consensus FY24 profit, which is expected to grow eight to nine per cent.