BRBR - BellRing Brands: Rating Downgrade As The Valuation Has Gotten Way Too High

2023-09-13 10:41:55 ET

Summary

• I recommend downgrading BRBR to a sell rating due to the significantly elevated valuation and overheated sentiment.
• BRBR's valuation has surged to unprecedented levels, trading at 27x NTM PE, which is well above historical averages and carries downside risk.
• Key concerns include the potential challenges in meeting optimistic sales growth projections for FY24 and the sustainability of growth driven by brands like Dymatize.

Overview

My recommendation for BellRing Brands (BRBR) is a sell rating, as I believe the sentiment and expectations around the stock are running too hot. The valuation has risen to an even greater level than when I wrote about it previously. In my opinion, there are visible risks that BRBR might underperform, and at that point, the market would likely rerate the valuation downwards back to its historical average. Note that I previously downgraded my buy rating to a hold rating for BRBR as the valuation had risen to 25x NTM PE

Recent results & updates

BRBR's strong organic sales of 20.3% are significantly higher than the consensus estimate of 18.7%. Pricing and product mix together contributed 11% to growth, while volume accounted for 9.3%. Premier Protein and Dymatize both contributed to the growth with strong product growth. However, rising input costs and increased promotional activity meant that gross margin growth lagged behind revenue growth during the quarter. However, EBITDA of $86.9 million was higher than the expected $82.2 million. The strong 2Q23 results have propelled the stock to even greater heights ($42 at peak) and have pushed valuation to 27x NTM PE. To put things into context, BRBR has never traded at this multiple throughout its entire trading history, which is way above its +1 standard deviation (24.6x). I believe the share price has already baked in all the optimism in the near-term, and the stock could re-rate downward very quickly based on the two bearish narratives I am seeing.

First, with regard to projections, management is anticipating a sales growth rate in the 10-12% range for FY24, with a greater likelihood of reaching the higher end of that range. The optimistic view is that Premier Shakes will continue to gain market share and that next year will see a 20% increase in production capacity, so projections of growth in the low teens seem conservative. However, this logic has a number of flaws. First, an increase in capacity does not automatically result in growth. Second, the price hike has contributed to the rapid expansion of both Premier and Dymatize. While I'm sure the company has reaped some benefits during this time, I find it hard to believe they can maintain such steep price increases without experiencing a decline in volume. Remember that once they stop this pricing increase engine, they will face a very tough growth comp, which will make the headline growth a very bad one for the investors to swallow.

Second, focusing again on Dymatize, I would not disagree that this brand has been a growth contributor. Since the year 2020, BRBR's powders, of which the Dymatize brand accounts for the majority, have shown extraordinary growth of >30% CAGR. As a result, the proportion of powder sales to total P&L revenue has increased from the low teens in 2020 to the high teens by 2023. However, investors need to know the impact of selling in and selling through. Given that this is a relatively new brand, it seems fair to assume that a lot of growth is via sell-in (i.e., filling up the rack and inventory space of end channels). These sell-ins bring in great revenue growth; however, they also mean that they are unlikely to repeat unless the sell-through (end-channel selling to end users) is just as strong as the sell-in motion. This puts up another risk that BRBR might miss expectations sometime down the road, which I expect to be quite catastrophic at 27x NTM PE.

As such, I am further downgrading my rating from a hold to a sell as I believe the expectation in the stock is running too hot, as seen from the share price action and valuation. All we need is one miss in expectations, and the stock price will take a nose dive.

Valuation

In order to get a sense of the possible downside if BRBR misses an expectation, I look to the period in 3Q22, where BRBR printed 8.2% revenue growth (3Q22 saw 8.2% revenue growth against a very tough 3Q21), the slowest growth it had ever printed at that point in time. As BRBR printed that result, the stock went down by 20% (dropping from $25 to $20), whereas the valuation (NTM PE) went down from 21x to 16x. Assuming a similar magnitude valuation re-rating if BRBR were to miss consensus expectations, the stock could rate down from 26x to 21x (25% downside), which is where it has historically traded at an average.

Summary

I am downgrading BRBR to a sell rating due to the significantly elevated valuation and overheated sentiment surrounding the stock. Despite BRBR's recent strong organic sales growth, rising input costs and increased promotional activity have impacted gross margins. The stock has reached unprecedented valuation levels, trading at 27x NTM PE, well above historical averages. Two key bearish narratives raise concerns. Firstly, the optimistic sales growth projections for FY24 may be challenged. Secondly, while Dymatize has contributed to growth, its substantial success might be attributed to sell-in rather than sustainable sell-through, which poses a risk for future performance.

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