I am talking about Breville Group. I got to know the company in late 2019, when my wife bought a Barista Express in the household (back then it was selling at C$599, now it’s ~C$1100, what inflation? even if you get one at C$900 with discount, that’s still 11% CAGR) Did not look into the company then but kept it in my monitoring list.
The stock price became interesting when COVID hit in March 2020. I rushed through a research in a week & bought the position around the same price as its secondary offering. Sold all when the P/E hits 40X in 2021 (implying a 2.5% earning yield)
As the price has dipped back to AUD $18, I thought to update the work now.
Small appliance industry itself is an interesting fishing pod, a long runway (long-termly, as more of the world population get lifted out of poverty, more demands would come from new middle class to command higher living standards) with limited market concentration. So great companies could plow back their retained earnings into similar ROE to produce wonders for shareholders.
With that being said, it is a field with formidable competitors in presence.
Disclaimer: this is not a pitch to buy the stock, I am simply sharing my learnings while researching the company & conclusion on the valuation, and my current strategy on this particular opportunity
1. Company History
The current Breville is a work from a series of Australia corporate maneuvers from late 1999. Retail Baron – Mr. Solomon Lew’s Premier Investments (another interesting entity, hope to be covered in the future) floated its homewares & electrical trading business to the public called Housewares International Limited (HIL) in 1999 while retaining a meaningful minority ownership.
Long story short, HIL continued acquiring oddball trading assets post IPO, along the way, it acquired the Australia appliance legend – Breville in Oct 2001 via a cash & share deal. Only in 2008 – 2009, the company finally tapped out on other business lines & decided to focus on growing Breville & small home appliance in large, therefore changing the name to Breville Group Limited then.
As of Oct 2022, the company has about AUD$2.7 Bln market cap, EV / Rev (normalized) at 1.7X, EV / EBIT (Forward) at 15X, P / E (Forward) at 19X.
YTD stock price went down 40%, I suspect it has been contributed by a. the inflationary fears hitting home appliance industry in large, b. trading multiples contraction (higher risk free rate ==> higher required earning yield ==> lower trading multiples) & c. concerns on the inventory built-up. The 1st one I believe it’s a macro shock & could deliver bargains to patient investors; the 2nd one it’s a valid factor, but if the price came to a reasonable level yielding a satisfactory return over long-term risk free rate, then it’s not a concern; The last factor, I would argue that Breville’s product position (mid to premium) & product nature (long product life cycle, non-perishable), making this a solvable concern too.
2. Does the company sell any brand-name products or services that might have a durable competitive advantage?
The answer is yes; Its main competitors: De’Longhi’s made quality felt less durable compared to BRG’s (go to a department store & test both); The material differences have been reflected on the gross margin %
The competitive advantages in my view came in following facets:
- Breville’s long culture on combining the strengths from: industrial design elegancy, engineering reliability & marketing storytelling
- Years of accumulated designs (they’ve been in this since 1960s) that are reusable & scalable & customizable
- The brand’s history (you can not use same $$$ of market cap to duplicate what the brand has accomplished since inception over night); It’s a great story
When you see the products are being displayed in museums, high-end stores, you know it’s not only about the functionality that the customers are paying
3. How are the operating competitiveness looking?
Size wise, Breville looks tiny comparing to industry behemoths like WHR (1/19 of Rev), NWL (1/10 of Rev); It is also much smaller than close competitor like DLH, 1691:HK; Lastly, it does not have a conglomerate base like what Braun has (P&G); But the quality of the business stands firm compared to competitors:
4. Is the company conservatively financed?
Historically, BRG carries little to no debt; The revenue of the business is seasonal (60 – 70% of the revenue is from 2nd half of the calendar year) & is subjected to mid-term business cycle (around 8% revenue decline when GFC hit).
I would assign a medium rating business risk to it. Therefore, a low debt load is needed to further proceed. After looking at credit metrics, it passes with flying color. Worst come worst, the company would be able to raise new capital leveraging its brand value, just like what happened when Covid hits, although the existing shareholders would suffer from dilution.
Out of the total AUD $350M debt facilities provided by its bank, BRG has used AUD $172M & it is labeled as long-term debt. Adding the capitalized operating leases, its total debt stands at AUD $222M. Two sets of metrics I would look at, ranking by relevance:
- Total Debt / (EBITDA – Capex) ==> 1.55X, I used most recent numbers to be conservative, the Capex could be further reduced as it had been at high-level to sustain BRG’s growth recent years ==> it means BRG could pay off its debt in 1-2 years
- EBIT / Interest Expenses ==> 20X, Debt / Capital ==> 27%
5. Have the earnings of the company been strong?
2013 – 2015’s contraction was contributed by both CEO turbulence, and the discontinuance of Keurig partnership (losing high margin commission rev)
6. Has the company been buying back its shares?
Not really, nor did it issue a significant amount of shares (suspecting due to Premier Investments being the largest shareholder)
From 2011 to 2022, its share outstanding increased from 129M to 139M. (0.7% dilution per year)
Considering that the company has been growing consistently, I reckon using up its cash in the business to be acceptable.
7. Does the management’s investment of retained earnings appear to have increased per share earnings and therefore shareholder value?
BRG has been acquisitive over the years, primarily focusing on buying new capabilities via cash & share deals in private markets, with earnout clauses. It does not break down the performance of these acquired divisions, unfortunately.
Here, I will measure the allocation results in general (both interval growth & external acquisitions)
From 2012 to 2022, BRG accumulatively earned AUD$ 5.22 per share, AUD$ 3.19 had been paid out and AUD$ 2.04 had been retained; EPS increased AUD$ 0.41, which gives a 20% return on accumulated retained earnings (corresponding to its long-term ROE average of 21%).
Therefore, I would argue that the company has done a wonderful job of investing the accumulated retained earnings.
8. Does the company show a consistently high ROCE & high ROE?
2021 & 2022’s declines in ROCE were mainly contributed by lower EBIT margin (higher design & research spent, the % to sales level more than doubled comparing 2022 to 2018, 9.1% vs 4%), 11% EBIT in 2022 vs 13% in 2019 & 2020. ROE did not suffer as much due to leverage gear applied.
This disruption in ROCE was largely caused by COVID-induced demand pull, explosive demand had been crunched into FY 2021 & 2022, and half of 2020, generating 2 – 3X of trendline growth (10-12%)
With a looming recession in the near future, BRG’s margin & invested capital turnover might further deteriorate for a year or two, but with its pricing power on unit level & non-perishable inventory nature, Breville should avoid significant asset impairment and operate at 5 -7% EBIT level with 80% invested capital turnover.
Long-termly, it is likely that the business would be able to generate 20% return on equity, considering its pricing power, reasonable amount of leverage applied & long growth runway.
9. What is the price range that makes business sense to purchase the stock?
With the current price at $18, you are getting an equity bond yielding at 5.42%; The coupon has a 10 – 12% CAGR track record over 10 years. Comparing with 10-year risk free rate of 4.2 – 4.3%, not bad.
Assuming you hold the share over 10-year and the coupon is able to compound at 10%, your coupon $ at end of 10-year would be $2.54, using the same 5.42% yield, you should be able to liquidate your share at $47; This will get you an IRR of 11% factoring the received dividend.
11% is definitely better than a saving account, but it’s also not amazing. You could argue the exit yield could potentially be lower, since they have been historically traded at 4.17% (24X P/E) over the past 10-year.
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If I need at least 15% IRR for holding this investment, what would my entry price look like?
Here, I would project out equity value & EPS, dividends over next 10-year with some key assumptions from above (ROE could consistent stay at 20%, it was 21% over the past 10-year, I will use 19% to factor the near-term headwind)
As a Canadian investor, I will also be subjected to 5% withholding tax on the dividend.
The exit multiple was the geomean of the last 10-year P/E ratio, which is smaller to the arithmetic one of 25 X.
The conclusion came to $16.11 per share. I have highlighted the key assumptions in the above.
10. What are valuation looking like with non-projection methodology?
I look at the business from two route:
Route 1: what is the replacement value of the net book value per share?
The key adjustments I made on the B/S were factoring into design & research value, customer relationship value and taking out the employee stock plan. NAV per share came to $6.7 per share
Route 2: what is the EPV (earning power value) per share?
Assuming no growth at all & revenue staying at $1.4 BLN level, adjusting for the growth spent in
SG&A, R&D and Capex, my EPV per share came to ~$15 per share, capitalized at 8.8% equity yield / cost of equity.
In sum, the maximum that I am willing to pay for this would be $15.
10. In Conclusion
As much as I like the company, the shareholder base & the current management’s track records, the current price still does not cut it. If I pay $18.3 now, my return as a Canadian investor over next ten year is likely about 13%.
In hindsight, my realized return was primarily benefiting from multiple expansion, since the business itself only improved 15 – 25%. Long-termly, multiple expansion is the least bankable assumption, period.
11. Observations
Since the IPO, Premier Investment barely changed its holding, from 2002 – 2022 (all mid-year accounted), its market value increased from $47M to $654M; Not including dividends, this represents 14% CAGR. With dividends, it’s definitely above 15%. For investing in good business, patience does pay off handsomely.
On the contrary, the original O’Brien family retained a sizable position after they sold Breville to Housewares International Limited, but they sold off their shares within 2 years. I doubt they had generated similar return comparing to Breville’s record.
Among the comps, there are other bargains available. I lean towards Breville since it has better durable competitive advantages & brand value to other traded peers, I’d rather to hold the best one over long-term in this field.
DLG came to a close 2nd. (this is also an interesting company, with family controlled shareholder & operator, long history & much more cheaply valued)
1691 seems to be mostly discounted, but it entangles a complicated corporate history & structure, in addition, the positioning of its portfolio would likely have less pricing power.
The “Sage” brand in EU was a “Band Aid” solution that the company came up in 2013, due to the fact that the Breville brand is not owned or operated by Breville Group Limited.
Jarden Corp, is a separately owned and managed company that offers a completely different range of products in the U.K. & Europe to Breville in other parts of the world. Jarden was an American consumer products company. Formed by the spin out of Ball Corporation’s canning business, the company became a wider conglomerate of consumer brands, particularly in the outdoors and home appliances market. Jarden was acquired in 2016 by Newell Rubbermaid, which renamed itself Newell Brands.
Long in short, it’s a mess that it’d likely need to be fixed down the road by BRG paying an one-time fee or some sorts to the rip-off. The “Sage” brand, in my view, not only dilutes the group brand value, creating confusion among customers, but also creates more works & complications in BRG’s inventory, distribution system.
