Why this broker just upgraded the Baby Bunting (ASX:BBN) share price to buy

The Baby Bunting Group Ltd (ASX: BBN) share price could get a boost this morning on the back of a…

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The Baby Bunting Group Ltd (ASX: BBN) share price could get a boost this morning on the back of a broker upgrade.

Shares in the baby products retailer slipped 1.6% to $5.43 yesterday when the S&P/ASX 200 Index (Index:^AXJO) fell 0.4%.

The drop in the Baby Bunting share price came after management provided an update at its annual general meeting.

Improving trends to lift Baby Bunting share price

While investors weren’t impressed, Morgans upgraded the shares to “add” from “hold”. The broker described the AGM update as an “upbeat assessment” of current sales and margin trends.

The ongoing COVID-19 delta lockdowns caused like-for-like (LFL) sales to dip 1.3% in the 14 weeks to 3 October. But that’s an improvement over the previous period and LFL sales would have jumped 4.7% if you excluded NSW and the ACT.

What’s more, online sales continued to grow strongly. Sales from this channel jumped 37.7% year-on-year even as it faced a tough comparable period when sales surged 126%.

Defying margins

But sales growth isn’t the only reason for Morgans’ bullish view on the Baby Bunting share price. The retailer’s margins are expanding at a time when cost pressures are rising.

“The gross profit margin was up 120 bp to 38.7% YTD. This was due to increased penetration of private label and exclusive products, sales mix and efficiencies in the supply chain,” said Morgans.

“We have also increased our LFL sales forecast slightly from 3.0% to 3.2%. This, combined with our higher gross margin assumptions, take our forecast NPAT up by 3.6% to $29.0m in FY22 and 3.8% to $36.1m in FY23.”

The increased forecasts prompted the broker to lift its 12-month price target on the Baby Bunting share price to $6.20 from $6 a share.

Other tailwinds lifting the Baby Bunting share price

There’s also room for Baby Bunting to grow. As the only national specialty maternity and baby goods retailer in Australia, it only has under 20% of the $2.5 billion domestic market.

Morgans believes it is well placed to take market share from non-specialist retailers, such as department stores.

There is also a new growth opportunity from New Zealand. The retailer will open its first stores across the ditch before the end of the year. If the offshore expansion is successful, Baby Bunting could use that as a springboard into other countries.

Not all good news

But Morgans warns that the Baby Bunting share price isn’t without risks despite these tailwinds.

“The company is busy on several fronts. Its transformation programme adds additional opex and capex,” said Morgans.

“Secondly, the launch of babybunting.co.nz appears to have been a success, but entering any new market brings risk and we will be following the sales data from the new stores in New Zealand very closely later this year.”

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Baby Bunting. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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