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Morningstar | European Expansion Continues to Deliver Strong Results for Breville

Narrow-moat-rated Breville is off to a flying start in fiscal 2019, reporting an interim net profit of AUD 44 million, up 20% on the previous corresponding period, or pcp. The comparable period was impacted by a tax adjustment, which if excluded would’ve seen NPAT increase by 15%, a strong result, nonetheless. The board declared an interim dividend of AUD 18.5 cents per share (60% franked), up 12% on the pcp. Management guided to EBIT growth of slightly higher than 11% during fiscal 2019, assuming no adverse change in economic conditions, which aligns with our 12.6% full-year forecast.

We have increased our fair value estimate by AUD 1 per share to AUD 11 reflecting: (1) continued strong performance in Germany and Australia; (2) a higher likelihood of successful expansion into additional European regions Switzerland and Benelux; and (3) time value of money. We have lifted our EPS estimates by around 4% on average over the next five years and expect the firm to sustain low-double-digit growth. Despite raising our fair value estimate, we continue to believe the stock remains overvalued at current prices. To produce a valuation closer to the current stock price, we would need to project average EPS growth of around 20% per year, which is more akin to our bull-case scenario. While the company has a formidable track record, we believe this level of growth is unachievable, especially against the backdrop of a softening global economy, and formidable competition in Europe.

The global product segment continues to perform strongly, growing revenue by 15% (9% on a constant currency basis) in the first half of fiscal 2019. This reflects double-digit growth in Australia, the U.S., the U.K., along with positive early results from the expansion into Germany and Austria. The company expects fiscal 2019 global product growth to be consistent with the last two years at the low-double-digit mark, and we envisage this pace being maintained for at least the next five years. However, the ongoing investment into new product development and marketing will keep the division's EBITDA margins capped at around 17% on average over the coming years.

Within the global product segment, Europe remains the strongest performer growing revenue by 40% (32% on a constant currency basis), albeit off a small base. This reflected double-digit growth in the U.K. under the Sage brand, along with the hugely successful expansion into Germany and Austria. The expansion into these new regions has been more positive than we expected and is already running an impressive 3.5 years ahead of the U.K. expansion which launched in the first half of fiscal 2014. Over the next year, the company will launch into Benelux and Switzerland, which are approximately 150% of the size of Australia and New Zealand in both population and GDP, which significantly grows the addressable market. Given the firm’s exceptional track record of expanding into North America and Europe, we project a similar trajectory for these new regions.

Despite a challenging macro environment in both Australia and the U.K., Breville continues to deliver double-digit revenue growth. This implies the firm’s new products are resonating with customers, and taking market share in the process, especially in the growing health food categories. The firm continues to increase its investment into marketing and research and development, which should help defend its brand strength and maintain product quality.
The smaller distribution segment grew revenue by an impressive 18% on the back of the North American Nespresso release. This segment distributes third-party branded products, with earnings reinvested into the moaty global product segment, which sells the Breville branded and designed products. Operationally, we don’t expect any major changes for the distribution segment, and forecast a more modest, mid-single-digit earnings CAGR over the next five years.