By Edmond Jackson from interactive investor.
It’s one of the great stock market success stories but is vulnerable to shifts in sentiment. Our companies analyst shares his thoughts after a savage sell-off in May.
Following my recent review of soft drinks firm Britvic (LSE:BVIC), it is pertinent to compare the risk/reward profile of AIM-listed Fevertree (LSE:FEVR) – both as a potential investment and to better understand Britvic.
It is also timely given May’s 20% stock retreat (macro worries, not about the company) which is attracting buyers to the posh tonics business.
Fevertree has made its own luck supplying a burgeoning niche for high-quality carbonated mixer drinks, to complement the growth in premium spirits. England could also be in the early stage of another historic gin craze that’s spreading rapidly abroad.
Yet Fevertree’s marketing success isn’t just alcohol-related: its tonic waters and ginger beer are high-quality refreshments on their own, and a new low-calorie range dials into a similar opportunity Britvic is exploiting – using fruit sugars rather than additives.
A justifiably high stock rating
Strong growth from a low financial base has also meant a premium stock rating where sentiment shifts mean higher volatility, hence higher risk than Britvic. You could also say that such risk is mitigated if you choose times to buy after a market drop and apply patience, accumulating a stake in the business.
At around 2,650p a share, Fevertree is capitalised at around £3.1 billion versus £2.5 billion for Britvic which is currently priced at 930p a share. Britvic is expected to make some £200 million pre-tax profit on £1.6 billion revenue with an operating margin of 7.3%, its growth rates advancing from mid to higher single digits thanks to an investment programme.
Fevertree lacks profit projections, according to Company REFS, but last year made £75.7 million pre-tax profit on £237.5 million revenue – top-line growth was 40% – with a 31.7 % operating margin.
It shows how the most successful companies are frustrating to value, where a subjective element means sentiment does shift. And yet the underlying dynamics suggest a high chance the company can grow into this rating. There’s time too: England’s most famous gin craze lasted from around 1700 to 1760!
Source: TradingView Past performance is not a guide to future performance
A good hedge against Brexit/sterling weakness
Both companies are leveraging their brands internationally: in 2018, Fevertree established its own operations in the US and extended its distributors across Europe: “As the world’s leading premium mixer brand with a strengthening global distribution network we are well set to drive the international opportunity as the move towards the premium long mixed drink continues to gather momentum around the world.”
This should mitigate risk of UK consumer retrenchment if Brexit sours – the UK represents 56.5% of total revenue.
However, even Brexit may not be such an issue given consumption of gin and other long drinks seems quite a metropolitan lifestyle, areas that tend to be more affluent.
Growing divisions of wealth in society mean, for example, that the best quality bars, hotels and restaurants feel compelled to stock Fevertree to complement their premium (high-margin) spirits offering.
Down from over-extended PE multiples
Britvic is a more defensive investment because Fevertree’s racy valuation makes its stock vulnerable to “risk-off” shifts in wider market sentiment. Since last summer, Fevertree shares have de-rated from 74 times 2018 earnings per share (EPS) of 53p, to a 40x range, assuming conservatively that EPS this year will be about 60-65p.
The rating is high on a 10-year view, but global potential for a business with £237 million revenue last year justifies a premium in the next five years or so.
See from the table how annual average historic price/earnings (PE) multiples ranged from around 70x to 110x – despite doubts among commentators – the whole way through the stock’s bull run from 175p in 2015 to 3,950p by last September.
That rating was exotic, buoyed by football’s World Cup and the royal wedding during a long hot summer, and meant a dramatic near-halving in the share price when the cold front of last autumn’s market jitters arrived.
Strong conversion of earnings to cash: a special payout?
The table below shows a trend of very strong cash flow versus capital spending needs, plus the cash flow statement within the 2018 accounts has net cash generated from operations up 35% to £58.4 million – 50.8p per share on a pre-tax basis, or £45.5 million/39.7p per share post-tax.
With investment constituting only £0.8 million spent on property, plant and equipment, £4.4 million was distributed as dividends. After year-end cash has soared 64% to £83.6 million there is scope to re-rate payouts – and also pay a special dividend – if no major new strategic move utilises this excess. The company seems to have plenty of organic growth potential than embark on acquisitions.
I’d also note a clean and vigorous financial growth profile than a serious gap between headline and “adjusted” figures due to exceptional costs and the like.
|Fevertree Drinks – financial summary|
|Year ended 31 Dec||2014||2015||2016||2017||2018|
|Turnover (£ million)||34.7||59.3||102||170||237|
|IFRS3 pre-tax profit (£m)||2.5||16.8||34.3||56.4||75.6|
|Normalised pre-tax profit (£m)||3.6||16.8||34.3||56.4||75.6|
|Operating margin (%)||23.0||28.7||33.6||33.1||31.7|
|IFRS3 earnings/share (p)||1.5||11.5||23.7||39.2||53.2|
|Normalised earnings/share (p)||2.9||11.5||23.5||39.2||53.2|
|Earnings per share growth (%)||744||300||104||70.0||35.7|
|Price/earnings multiple (x)||49.8|
|Annual average historic P/E (x)||112||65.9||73.4||109|
|Cash flow/share (p)||4.1||8.8||17.8||28.2||25.0|
|Dividend per share (p)||0.3||3.1||6.3||10.7||14.5|
|Covered by earnings (x)||9.7||3.7||3.7||3.7||3.7|
|Net tangible assets per share (p)||7.6||18.7||39.8||76.0||92.0|
|Source: Company REFS|
May’s share price fall relates to macro events
2019 saw a 24% rebound in the share price from 2,200p to 2,720p by end-April, then a renewed slide despite nothing adverse in Fevertree’s newsflow. The last two regulatory news announcements in April showed two global investors slightly increasing their stakes, while the 24 May AGM cited “further encouraging operational progress across our key international regions.
“Whilst we are mindful of last year’s exceptional summer trading performance in the UK, we remain confident in achieving board expectations for the full year ending 31 December 2019.”
Most likely the drop in share price relates to risk aversion among investors after US/China trade negotiations hit the rocks, and further inversion of the US yield curve on Treasury bonds invited fear that the US economy is being propped up by tax cuts late in the business cycle.
On Wednesday 29 May, Fevertree’s price fell to 2,600p, which has triggered buying up to the 2,640-2,650p area – a notional support level, albeit short timeframe.
A marketing sweet-spot with plenty of long-term upside
Stand back from stock volatility and instead focus on Fevertree’s ability to capitalise on demand for premium mixer drinks, plus low-sugar/non-alcoholic beverages.
Its Refreshingly Light range delivers on the latter without artificial sweeteners, is offered in supermarkets and gets very good consumer reviews.
I’ve found the Elderflower tonic water great for picnics; the launch of a Cucumber tonic proved a hit last summer, also a Clementine tonic last Christmas.
Besides another gin craze spreading to the US and Spain especially, you wonder if climate change could play a part here.
Might extended hot summers encourage affluent people towards sophisticated long drinks?
Pragmatically: average your way in
Fevertree’s stock is quite a victim of its success, a justifiably high rating making it exposed to sentiment shifts. Nervous investors should probably steer clear, but if you can see through to a quality growth business, then you’ll accumulate its stock when the market gets jittery.
So, broadly, the approach is to ‘buy the drops’, although I admit it is trickier to assert exactly at what price given the macro/markets context could get hairier at any time. However, the current price around 2,650p appears fair to buy within a general stance of: Buy on weakness.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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