BRBR - BellRing Brands: Strong Business Growth Momentum But Valuation Remains A Headwind

2023-12-27 11:57:49 ET

Summary

• BellRing Brands' organic growth exceeded expectations, with strong sales and volume growth in its Premier Protein segment.
• The company's capacity expansion plans and increased shelf space are expected to drive future growth.
• However, the high valuation of the stock remains a concern, leading to a neutral hold rating.

Overview

My recommendation for BellRing Brands ( BRBR ) is a hold rating, as I now believe the business is doing much better than I previously expected. Organic growth came through as capacity expanded, and the growth outlook appears positive. However, I am still concerned with the valuation that BRBR is trading at; hence, my hold rating is more of a neutral view on the stock. Note that I previously assigned a sell rating for BRBR on 13 September due to the elevated valuation that it was trading at. My view back then was that BRBR will not be able to sustain its high trading multiple of 25x NTM PE, and valuation de-rating will cause share price to fall.

Recent results & updates

The market has humbled me in that valuations can, evidently, stay stronger for longer than I expected. It is clearly not wise to go against a business that has strong growth momentum and positive sentiment. My mistake was jumping to the conclusion that growth would slow and miss estimates, despite the business still growing at 20.3% organically last quarter (beating consensus estimate). For this update, I look to evaluate BRBR based on its current growth momentum and upcoming growth catalyst and balance it with my view on valuation. Overall, I am revising my rating to a hold (neutral rating) as I agree the business continues to do well, but the valuation is something I cannot be comfortable with.

On a full year basis, BRBR grew revenue by 21.5% to $1.67 billion, accelerating from the 10% growth seen in FY22. Gross margin also improved by almost 110bps to 31.81% y/y. Growth acceleration and gross margin improvement led to better profitability at the net income line, where margin improved by almost 200bps to 10.12%. For 4Q23 , BRBR once again showed tremendous strength in organic growth. The business reported organic sales growth of 24.6%, beating consensus growth estimates again, driven by volume growth of 19.4% and 5.2% from pricing and product mix [price/mix]. By segment, Premier Protein sales grew 30.2%, driven by 21.0% volume and 9.2% from price/mix. Specifically, ready-to-Drink [RTD] shakes grew a staggering 28.9%, mainly driven by robust volume growth. The positive note here is that RTD volume growth was largely attributed to higher shake production [i.e., capacity], more marketing [i.e., promotions], and the reintroduction of certain flavors. On the other hand, Dymatize net sales declined by 0.9% as it lapped trade inventory build in tailwind last year.

The first of my two concerns previously was that Premier Shakes might not be able to grow as much as expected, even with more capacity coming online. Clearly, I underestimated the brand's strength and underlying demand. Improved capacity literally translated to more demand. As such, I am now turning bullish on the growth prospect and believe that Premier is positioned for continued strong growth in FY24 as BRBR. There are a couple of reasons for my change of stance:

1. BRBR is going to continue expanding production capacity, which should translate into growth as the constraint is supply and not demand.
2. BRBR is gaining more shelf space, which means more capacity to sell to consumers.
3. Relaunched products and seasonal offerings are gaining traction, which should help with near-term sales growth.
4. BRBR is restarting its promotion engine, which should help drive demand.

With regards to point (1), expansion plans are well on track, as BRBR added 17% capacity in FY23, which is well ahead of its low-double-digit target. In FY24, management is expecting to add an additional 20% capacity. I believe this target is easily achievable as 40% of the 20% expected increase is due to the timing of capacity expansion in FY23 (i.e., FY24 sees an easy FY23 comp), and 20% of the expected increase is expected to come from ramping up of new capacity in FY23 (since the facilities are already built and running, ramping up should not see much hurdle). With these, 60% of the 20% expected capacity increase (20% * 60% = 12%) is pretty much in the bag. As such, the risk of missing the 20% capacity expansion target is limited to 8% (20% - 12%). This 8% is expected to come from Post's greenfield facility coming online in 1Q24 and two existing partners adding lines. Given the performance in FY23, I think this should not be a big concern. The better news is that BRBR would not need to add more capacity until late FY25 if FY24 capacity grows as planned. Which means there are no major hurdles to the growth outlook in the near term.

As for Dymatize, my concern regarding sell-in vs. sell-through came true to a certain extent.

"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 ." Creative Capital Ideas 2Q23 update

Sales fell by 0.9% as it lapped the high sell-in motion last year. However, the underlying demand remains incredibly robust, as consumption was up 38% and there was double-digit growth in nearly all channels. The evidence is clear in the pudding that Dymatize is a very strong brand, and I am not going to discount it. I now expect growth to be strong in the coming FY24 as the inventory sell-in headwind eases and management kicks up a notch on marketing. Additionally, I would also highlight a potential growth catalyst that would further drive demand for Dymatize. According to research done by BRBR, GLP-1 users are likely to consume protein shakes to maintain muscle and offset other side effects. If true, I believe BRBR will be a major beneficiary of this trend as it expands BRBR's targeted consumer base.

Valuation and risk

According to my model, I still don’t see an attractive upside to the stock. My target price is $60.79 in FY24, representing a 9% increase. I agree that business growth is going to be strong in the near term, driven by capacity expansion, a strong brand and underlying demand, and an increase in promotions. These should drive similar revenue growth of 15% (CAGR from FY16 to FY22) over the next 2 years. I expect net income to grow faster as margin expands in FY25 (management not adding capacity in FY25), resulting in near-term income growth of ~43% over the next 2 years (FY25 net margin expands because BRBR is not going to add more capacity).

However, my concern regarding valuation remains. Giving BRBR credit for its strong organic growth performance and execution. I expect BRBR to trade at an elevated valuation relative to history in the near term. Pre-FY23, BRBR NTM PE traded in the high teens to low-20s. As organic growth performance remains strong, valuation has surged all the way up to the current 33x NTM PE. In my model, I assumed BRBR would continue to trade at 33x NTM PE; however, even at this elevated multiple, the upside is not attractive.

For monitoring purpose, I would continue to track BRBR capacity expansion cadence, Dymatize sales acceleration, and the impact from GLP-1.

The upside risk is that the BRBR valuation can go much higher than the current 33x NTM PE. My previous mistake was that multiples were unlikely to go further up, but they did. If it happened once, it could happen again. Also, management could turn a lot more aggressive on marketing than expected, which could translate to stronger sales growth in the near term, thereby driving further increases in valuation.

Summary

Overall, BRBR did very well for 4Q23, but I am recommending a hold rating. I do believe that BRBR capacity expansion plans, increased shelf space, and promotional activities are expected to fuel growth. However, I remain concerned about the high valuation that BRBR is trading at. My model suggests that even if this valuation persists, the upside is still not attractive. Hence, while recognizing BRBR's growth trajectory, my neutral stance reflects valuation concerns.

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