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3 reasons why the Bubs (ASX:BUB) share price is worth watching

Bubs (ASX:BUB) is an ASX small cap that growth-focused investors might like to keep an eye on. 

Bubs (ASX: BUB) is an ASX small cap that growth-focused investors might like to keep an eye on.

What is Bubs?

Bubs was founded in 2006 by Kristy Carr and was listed on the ASX in January 2017. Its infant formula is based on goat milk and it also sells organic baby food. Bubs recently acquired NuLac Foods, Australia’s largest producer of goat milk products, it also guarantees exclusive supply of local goat milk from Australia’s largest herd of milking goats.

3 Reasons why the Bubs share price is worth watching

Reason 1: Vertically integrated – Bubs has made acquisitions to become a vertically integrated operator including getting access to the largest goat herd in Australia and an important canning facility. Deloraine is one of only 15 canning facilities in Australia authorised by the Certification and Accreditation Administration of China (CNCA). At the time Bubs said the facility had the capacity to process 10 million tins with its existing production line and could double capacity with investment. This gives Bubs more control over costs and it only has to rely on itself.

There are benefits to not owning your whole supply chain, A2 Milk (ASX: A2M) has done very well without owning the cows or canning facilities.

Reason 2: Strong and growing distribution channels – Bubs has made a number of exciting distribution announcements over the past couple of years to expand it from a small Aussie player to the footprint of a business that could seriously grow. It has made partnerships with Beingmate in China (a leading domestic infant nutritional company), an equity-linked alliance with Chemist Warehouse, Kidswant (the market leader in infant and child retail with the largest share market in China), Alibaba, a Vietnam deal and it also recently announced a distribution announcement with Coles (ASX: COL), Woolworths (ASX: WOW) and Baby Bunting (ASX: BBN).

The recent expansion into making and selling (cow) organic grass fed infant formula could end up being another large pillar to the business if it can win decent market share in the premium infant formula segment of the market.

Reason 3: Financial inflection point? – Bubs’ revenue has been growing at a fast pace for a while and FY20 is attractive – FY20 Q1 revenue growth was 58% to $14.21 million. FY20 Q3 revenue growth was 67% to $19.7 million (up 36% on Q2). In that FY20 Q3, infant formula revenue rose 137% on the prior period and total Chinese revenue rose 104% (representing 24% of gross sales for the quarter). These growth numbers are impressive considering many of the new distribution agreements I mentioned were only just coming into force.

It’s Bubs’ margins and cashflow that are worth thinking about the most.

In the FY20 half year result Bubs said its gross margin was 24% at December 2019, 21% at June 2019, 19% at December 2018 and 14% at June 2018. This is being helped by the fact that infant formula revenue is growing fast and it’s a higher margin product (infant formula had a 41% gross profit margin in December 2019).

COVID-19 is causing strong demand for Bubs’ products. But it’s also keeping a lid on costs. This led to Bubs generating a positive operating cash flow of $2.3 million for the March 2020 quarter. Continuing revenue growth from here could see Bubs remain cashflow positive into the future, much sooner than I was expecting.

Is the Bubs share price a buy?

That’s the question isn’t it? Bubs currently has a market capitalisation of around $600 million, so there’s already quite a lot of expectation built into the valuation. As with most infant formula businesses, there is a major risk that it’s quite dependent on China for growth right now.

But it’s quite rare to find a business that is still at the early stages of its growth journey and has many of the boxes ticked (fast revenue growth, internationally growing, very long potential growth runway, good cash balance ($36.4 million at March 2020), focused management and so on). I’d be very happy to buy some shares today for the long term.

Technology shares may have the most promising growth of all though.

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Disclosure: at the time of publishing, Jaz does not have a financial interest in any of the companies mentioned.

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