Don't Jump Into Blue Buffalo

In a report published Tuesday, Morgan Stanley analyst Dara Mohsenian initiated coverage of Blue Buffalo Pet Products, Inc. (NASDAQ: BUFF) with an Equal-weight rating and $29 price target. The analyst believes that Blue Buffalo's peer-leading long-term return and EPS growth profile, as well as its strategic potential, is also priced into the stock.

"We believe BUFF boasts one of the strongest fundamental stories in the CPG group as its strong competitive positioning in the attractive pet category should drive robust long-term growth, as well as strong ROIC and solid free cash flow generation," Mohsenian stated.

The analyst expects the company to generate peer-leading revenue CAGR during 2014-2018, driven by Blue Buffalo's favorable sub-category exposure to the rapidly growing whole natural segment, in which the company is already the "clear leader".

The analyst also believes that revenues would be driven by opportunities for white space expansion, both in the United States and internationally, along with opportunities to expand distribution in the non-superstore segment.

According to the Morgan Stanley report, among the revenue growth drivers are "favorable demographics as BUFF's skew toward puppies/kittens should support market share gains over time given high brand loyalty in the category."

In addition, the analyst believes that the company has significant opportunities for margin expansion, "as the gross margin uplift from bringing a portion of manufacturing in-house, a mix shift to wet food/treats, and volume leverage given robust topline growth will more than offset SG&A deleverage from significant upfront investments in the vet channel/internationally," Mohsenian said.

The analyst expects the company to be able to drive margin expansion of 90 bps annually through FY2018.

"While we are very favorable on BUFF's fundamentals, we believe valuation reflects its robust growth profile & asset efficiency," the Morgan Stanley report added.