Blue Buffalo Pet Products (BUFF) is on the Hedgeye Consumer Staples Best Ideas list as a SHORT.
HEDGEYE OPINION
For the time being BUFF is a fast growing company, with a strong top-line and robust margin growth, but on the margin BUFF seems to be topping out. In 3Q16 BUFF reported revenues of $288.0M missing consensus expectations of $290.8M. Moving to the bottom-line, which was slightly assisted by a lower tax rate of 33.1%, reflecting the early adoption of a new accounting standard for the exercise of stock options, BUFF reported EPS of $0.22 versus expectations $0.20.
Pet superstores which represent 61% of their mix (PetSmart = 38% and Petco 23%), continued to slow in the quarter. Superstores experienced pressure as they lapped particularly high levels of discounting in the back half of last year, and traffic in this channel remains soft, which BUFF specifically called out as a reason to stay cautious on superstores. Outside of pet superstores which represented the other 39% of sales, BUFF’s sales grew by 36%. As sales continue to move online and to other channels, growth will get progressively worse for the pet superstore channel, which will continue to impact BUFF. Online is where brands play on a more level playing field, gone are the times of BUFF dominating the vision of consumers with shelf space at superstores.
Looking beyond current channels, International and Veterinary are a focus for the Company but remain inconsequential to the top-line. BUFF grew SG&A by 23% which was primarily driven by investments in revenue-generating activities as they continue to build out their capabilities in these two growth drivers. Management expects to see a benefit from these channels in 2017, but we remain cautious on their ability to get a return on this investment. From our research there is currently a rather negative bias towards BUFF in the veterinary channel and the challenges with establishing a brand internationally could slow them down.
Gross margins in the quarter were 46.3%, driven primarily from supply chain efficiencies, including lower input costs. Management is expecting FY16 GM to be roughly 45%, which implies a sequential decline due to typical seasonality as BUFF put it. We won’t get 2017 guidance until they report 4Q results, but given where GM’s are they could potentially guide to lower gross margin in 2017, looking for a recovery in 2018 when the new facility is up and running.
NOTABLE COMPANY THOUGHTS
“We are watching the Rachael Ray brand, Nutrish. That is gaining momentum in grocery stores, but we really feel that competes more so with the likes of Beneful as it is one of their lower price point product lines. So, again, I don't think there is any new game changer here that has taken place.” (Billy Bishop, COO)
HEDGEYE – Whether they will admit it or not, this category is getting more competitive and upstart brands will continue to enter the market and nip at their heels.
“The category growth during Q3 was a bit slower than recent periods, but still low single digits. What we saw, as you noted, the slowdown across all the tracked brick-and-mortar channels -- that is food, drug, and mass, superstores, and neighborhood stores, et cetera, with e-commerce growing very rapidly. And the channel shift was pretty similar to other CPG categories.” (Kurt Schmidt, CEO)
HEDGEYE – Core channel is slowing for BUFF which will lead to erosion of their top-line over time.
“While pet parent demand for our products is robust, we are not immune to the changing dynamics in the retail landscape, especially in the short term, and we have seen some variability among our distribution channels. Consistent with what we discussed on our last call and the market trends I just described, our sales through the pet superstore channel have softened, while we have seen continued strength outside of superstore.” (Kurt Schmidt, CEO)
HEDGEYE – “We are not immune,” this quote really summed up the somber tone of the call. BUFF is subject to the channel shifts and changing consumer confidence just as any other brand is. With BUFF up on a pedestal trading at the high multiple, when push comes to shove and the business starts to slow on the margin, the stock price will follow suit.
“I also wanted to provide a few words about our litigation settlement. As you read on our November 3 press release, we announced that Blue Buffalo and Nestle Purina have agreed to settle all outstanding litigation between our two companies. In connection with the settlement agreement, we have included a $32 million pretax charge as a discrete line item in the financials.” (MikeNathenson, CFO)
HEDGEYE – This is generally a positive that they can put this behind them, and although management stated they don’t have to change their packaging, the way they advertise may have to change.
QUICK COMPS
- Revenue: $288.0M vs FactSet $290.8M
- Adjusted EBITDA $74.0M vs FactSet $69.4M
- EPS: $0.22 vs FactSet $0.20
FY16 GUIDANCE
BUFF raised bottom-line guidance while keeping top-line guidance the same as they are being cautious regarding the retail landscape. BUFF has said that top-line should be expected to grow 10%+ but with the top-line guidance for FY16 remaining the same it leaves room for top-line growth to fall to the HSD growth in 4Q. FY16 net sales guidance implies that for 4Q sales could be in a range of up 7.5% up to 11.3%, with 9.4% being the midpoint, which leaves a lot of room for disappointment. And with a slowing retail channel, slowing consumer environment, and priced to perfection multiple, we wouldn’t want to be on the wrong side of that disappointment.
- EPS: $0.78 - $0.79 vs prior guidance of $0.74 - $0.79 and FactSet $0.76
- Reaffirms revenue $1.14B - $1.15B vs FactSet $1.15B
- Company is projecting 45% gross margin for the full year
- CAPEX projected to be $50M - $60M
Please call or e-mail with any questions.
Howard Penney
Managing Director
Shayne Laidlaw
Analyst
