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FTSE 350: Beverages stocks change the recipe

With the sugar tax a step closer, companies will need to make sure their recipes meet the mark
January 26, 2017

The direct shot at the soft drinks industry by former chancellor George Osborne stands out as a significant event last year for the beverages sector: the MP for Tatton proposed a sugar levy on the sector, effective from April 2018. Roger White, chief executive of AG Barr (BAG), called the move “punitive and unnecessary”, given that companies such as his were already investing heavily in reformulating recipes and launching low- or no-sugar versions of their products.

In 2017, it will be important to monitor the pace of change at companies such as Barr and rival Britvic (BVIC). How much more are they planning to spend on rejigging recipes? How are sales of the alternative versions progressing and are they fully replacing lost sales of their more sugary cousins? There’s also the fear of rising inflation, which could cause a subsequent squeeze on household incomes, potentially leading some consumers to jettison branded goods for own-label alternatives. Although neither Barr nor Britvic have high exposures to foreign currencies, which protects them somewhat from imported inflation, pricing will be crucial in supporting volumes in the event of tighter consumer purse strings.

And volume is something that’s a key issue for Coca-Cola HBC (CCH), the company that bottles the eponymous drink. In its most recent update, the company saw volumes drop in its established and developing markets divisions, with volume growth only evident in its emerging markets business thanks to demand in countries such as Nigeria and Romania. Cost management will be as important as ever, as will the company’s significant hedging policy.

Over in the harder aisle, Diageo (DGE) now stands alone in the FTSE 350 after the mega-brew merger of Anheuser-Busch InBev (BE:ABI) and SABMiller went ahead, removing the latter from the UK stock

market. The beverages sector has seen its price-to-book ratio continue to rise in recent years and so there could be pressure on stocks within it: arguably the most important thing to watch with Diageo is its presence in the US. There were signs towards the end of 2016 that it was beginning to defend and reignite growth there, a key market for the company via its Smirnoff vodka and Captain Morgan rum brands.

Price (p) Market value (£m)PE (x)Yield (%)1-year change (%)Last IC view
Barr (AG)51460015.92.6-0.7Sell, 520p, 27 Sep 2016
Britvic5921,557124.1-11.8Buy, 589p, 1 Dec 2016
Coca-Cola HBC (CDI)1,8066,559263.331.7na
Diageo2,16154,38521.82.721.4Buy, 2,147p, 28 Jul 2016

 

Favourites: The move by Britvic to get rid of added sugar in its Robinsons brand was the right decision given the political wind direction, but the company acknowledged in December that fewer consumers than expected had switched to the less sugary version. We’re also optimistic on Britvic’s entry into Brazil and the US. Coca-Cola HBC was highlighted as one of the ‘most overlooked’ stocks in our Stealth Stocks feature last year and we think the company’s fundamental link to the soft drinks giant is a positive. With Diageo, its overseas earnings are attractive given the current weakness of the pound and it too seems to be recovering in the important US market

Outsiders: We’re least optimistic about AG Barr given its heavy UK focus. While it has invested in concentrating production in two sites, we feel the sugar tax and the potential consumer spending challenges this year could be problems for the company.