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How Bubs Australia can grow revenues in the face of coronavirus

After a stellar start to 2019 in which its share price soared to a new all-time high of $1.615, shares of organic baby foods manufacturer Bubs Australia Ltd (ASX: BUB) have been on the downtrend for the better part of 12 months.

Bubs has significant China exposure – 19% of its gross sales for first half of FY20 came from China – which means it will feel the negative impacts from the economic slowdown that has occurred as a result of the coronavirus outbreak.

How can Bubs grow its revenues?

A new supply deal recently inked with Australia’s largest supermarket chain, Woolworths Group Ltd (ASX:WOW), could significantly boost Bubs’ domestic sales and help it ride out the volatility currently sweeping through global equity markets.

The new Woolworths agreement is a real win for Bubs, and should drastically increase its product visibility for consumers across Australia. Prior to this new supply agreement, Bubs had a deal in place whereby Woolworths stocked its Goat Milk Infant Formula products across 120 of its stores. This has been significantly expanded under the new agreement, with all eight of Bubs’ formula products now being stocked across Woolworths’ retail network, some in up to 700 stores.

Overall, the new deal will double Bubs’ domestic retail exposure, and it is an indication of the strength of the company’s sales performance. Woolworths wouldn’t expand the supply agreement by such a degree if Bubs’ products weren’t selling well.

Impact of the coronavirus

The deal couldn’t have come at a better time for Bubs. Although the coronavirus is now spreading globally, it is still the Chinese economy that has been hardest hit by the outbreak. Even if the infection rate starts to decline, it could take months for the economy to recover, which will continue to drag down revenues for companies with significant Chinese exposure.

A whole raft of companies across a range of industries have now issued earnings downgrades as a result of the virus, from healthcare giant Cochlear Limited (ASX:COH) to Treasury Wine Estates Limited (ASX:TWE).

One of Bubs’ key competitors in the infant formula space, Blackmores Limited (ASX:BKL), downgraded its full-year guidance to such a degree that it put its shares into a trading halt prior to the announcement. However, Bubs will hope that the new Woolworths agreement will go a long way towards offsetting any deleterious impacts from China.

In its first-half FY20 results released to the market Wednesday, Bubs claimed it had yet to notice any negative effects from the coronavirus outbreak. Instead, it made the case that demand for infant formula and long-life dairy products may actually increase in China as a result of the virus, as these are both regarded as staple pantry items. It argued that – now more than ever – consumers will need reliable and healthy sources of dairy, for both themselves and their infant children.  

Despite these reassurances, the results drew a lukewarm response from the market, with Bubs’ share price dropping 3% on the day of the release, despite the company reporting a 37% increase in revenues and significant gross margin expansion.

Foolish takeaway

I think Bubs’ attitude towards the coronavirus is overly optimistic. It’s difficult to envisage a scenario where the outbreak doesn’t suppress Bubs’ top-line growth.

The company has significant Chinese exposure, and the outbreak is hurting supply lines across Asia. Whether or not demand exists, it may become logistically difficult for the company to actually get its product to consumers in China. In a worst-case scenario, these disruptions could still last for months.

This means that the potentially significant expansion in its domestic market penetration couldn’t have come at a better time. By growing its sales at home in Australia, Bubs may be able to offset much of the revenue drag from China – meaning it may be one company with the potential to rebound strongly once the dust settles on coronavirus.

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Rhys Brock owns shares of Blackmores Limited, BUBS AUST FPO, Cochlear Ltd., and Treasury Wine Estates Limited. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Cochlear Ltd. The Motley Fool Australia owns shares of and has recommended Blackmores Limited and Treasury Wine Estates Limited. The Motley Fool Australia has recommended BUBS AUST FPO and Cochlear Ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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