The 'high PE' brigade misses a critical point i.e. the ability of BAL to increase profit margins (take operating leverage) at the same time as sales grow rapidly. This will very quickly bring the PE multiple down. There is already ample evidence of operating leverage in the FY15 result (look at NPAT doubling 2H15 over 1H15). BAL's NPAT margin of 7% in FY15 is still below what BAL should be able to deliver medium term, which is closer to the 10-15% range if you look at comparable companies and keep in mind their low cost digital marketing strategy.
Next to the question of sales growth potential. There is probably still some room left for growth in Australia, but the next key test for the company will be success in Asia, and particularly China. On this front I've got a lot of comfort. Yes, natural feeding is well and good, but not all mothers can produce enough milk to satisfy a growing baby. This is a particularly acute issue with Asian mothers. If you read BAL's first upgrade late in 2014 they commented on customers buying tins of BAL product off the shelf in Australia and shipping it up to friends and relatives in China. What is really exciting is that those tins are being sold to those friends and relatives at much higher prices than BAL will sell them for (reflecting the high cost of are freighting a handful of tubs of infant formula to China). Chinese parents want the best for their kids. For the most part Chinese families are still having only 1 child. Chinese parents will pay extra for infant formula they perceive as being beneficial to their kids. Australia has a great reputation for clean food, and Chinese mothers will pay for that.
This is not dissimilar to Australia/NZ also. I've been amazed at the willingness of some friends who are struggling with mortgage payments and skimping on most things in their lives to pay a premium for what they perceive to be superior infant formula. Bellamy's fits this product positioning nicely.
If you agree with Morgans that BAL will deliver sales of around $200m this year, and that NPAT margins tend towards 10% as the company takes some leverage, then they should be able to deliver close to Morgan's $20m NPAT forecast. At a $710m market cap that results in a still high PE of 35x, but hardly outrageous for a company doubling profits year on year. Or put another way that's 3.5x revenue, again very reasonable for a company growing this fast and with further margin growth potential. Most importantly, all this growth is organic - with the potential for a long period of fast growth if they can crack the Chinese market - and the company is earning a very high return on equity (approaching 40% this year) so every $ of revenue growth is adding a lot of value to the business. Medical device companies with a similarly high return on capital but which are growing slower trade on similar PE multiples around 30x forward. So you could well argue there is significant further upside in BAL's share price, particularly if they can deliver the goods in Fy17.
Note that I am not arguing that BAL's share price will not face a correction at some point, all share prices do, and that correction may even happen soon. But there is good reason to think that, overall, the re-rating of BAL this year is justified and that there may be further to go.
BAL Price at posting:
$7.32 Sentiment: Buy Disclosure: Held
