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Trading Diary

Trading Diary – 26 September 2019

We’ve sold our position in People Infrastructure at a small loss. Since the overall market trend remains up, we’ve immediately reallocated this capital back into the market and opened a new position in Baby Bunting (BBN).

Following this change, we continue to hold a total of 18 stocks in the Model Portfolio.

Sell

People Infrastructure (PPE)

Position closed at 7% loss

The stock has been weak since the announcement of full-year results. The results were in line with expectations. However, since the stock had already appreciated significantly in the leadup to this earnings season, the market required something special to continue the uptrend.

Nothing new came out of the earnings report. The company continues to target 10% per annum of organic earnings growth. They expect to achieve this through a combination of growing top-line revenue and margin expansion. The workforce management industry is expanding, and PPE will benefit from this.

The company is already earning industry-leading margins. Therefore it will be difficult for these to expand much further, especially if they grow operations into less specialised areas. At most, they might squeeze another 100-150bps of margin, but only if they remain focussed on their niche.

The company expects to generate another 15% per annum of earnings growth via acquisition. Explicitly targeting 15% per annum might have the effect of pushing management into pursuing acquisitions for the sake of achieving this number alone. Purchases should only be made opportunistically at the right price. Not to meet some arbitrary growth number.

Being a consolidator in a fragmented industry is fraught with danger. The danger lies in paying too much and using debt. PPE is still conservatively financed and can continue pursuing its strategy. However, they will need to demonstrate that they can buy well and generate steady cash flow.

In any event, I was cognisant entering this position that we might already be late to the party. So far, this has proved to be the case. The market appears to be pausing to give the company some time to test its growth strategy. As a result, we’ve moved to the sidelines and redeployed capital into more attractive opportunities.

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Buy

Baby Bunting (BBN)

Technicals

Baby Bunting has been in a trading range oscillating between $2 and $2.50 for more than 12 months. They’ve been in this range since the release of their full-year earnings in 2018. The stock popped more than 30% on that day. A few days later, one of their largest shareholders used the opportunity to offload their entire stake. For more than 12 months following this, the stock moved sideways.

Upon the release of their latest full-year results, the stock finally broke out of this trading range. The stock now appears to be establishing itself in a new uptrend. The price is back above all-time highs. There was a brief pullback into the all-time high zone, which is where we’ve bought our position.

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Fundamentals

The fundamental picture for BBN is solid. The company ranks in the top decile amongst our investment universe for growth. Revenue has grown by 19%. More importantly, for a retailer, comparable store sales growth was 8.7%.

Gross margin improved by 190 bps to 35%. This outcome resulted from adjusted trading terms, range revisions and increased exclusive products and direct imports. The company has indicated that they expect this trend to continue in the year ahead. Management expects gross margins this year top exceed 36%.

Asset turnover, return on assets, and free-cash-flow to total assets have all improved.

Narrative

The narrative for Baby Bunting centres around market share, stores, margins and online. So a lot is happening.

Market share

The baby goods retail landscape has changed. Baby Bunting is the only national specialty baby goods retailer in Australia. Competitors have closed and liquidated stock. BBN estimates that they’ve been able to capture ~30% of shut down competitor market share where they have stores. They expect that store closures have left a ~$138 million market share opportunity.

Margins

The company is growing margins. They’ve done this in several ways. New product range improvements and direct importation have helped. More importantly, though has been the fact that unsustainable discounting has normalised post competitor closures.

Going forward private label and exclusive products will allow BBN to differentiate their product offering. BBN had 56.5% growth in its home brand and unique products, now 27.6% of total sales in FY19. They have a long term target of 50% and 35% in FY20.

Stores

With 53 current stores and network plan of 80 plus stores, BBN is a store rollout story. The new store economics are impressive. The groups average new store has earned >70% returns on invested capital after four years of operation.

Online

Online (inc. click & collect) sales growth of 46%, now 11.8% of total sales. The company appears reasonably well placed against the likes of Amazon. ~75% (187 products) of their top 250 selling SKUs are not available on Amazon. Moreover, ~37% of the top 250 selling products
in 2H FY19 were exclusive to Baby Bunting.

The graphic below tells the story.

Upshot

Most of the ingredients are in place for the emergence of a new uptrend in the stock. The main concern here is that the growth path is very well known and understood. As a result, there’s not much opportunity for surprises to the upside.

The best trends emerge from high uncertainty — especially where there’s a significant divergence of opinion as to the ultimate value of a company.

However, BBN has operating momentum on its side, and this tends to be self-reinforcing. This operating momentum could prove enough on its own for the company to continue to surprise to the upside and for the market to continue to push the stock higher over time.

By Danny Sandler

Founder of Ocean Asset Management.