Britvic faces further squeeze

Despite the prevailing consumer gloom, beverage companies have generally prospered in recent years, thanks to the strength of their brands and the subsequent ability to pass on rising input costs to customers. As small-ticket purchases, drinks buying has held relatively steady, especially soft drink spending - take-home market volumes were up 3.3 per cent in the past six months and even more on a value basis.

That's helped lift the sector by 19 per cent over the last year and by a whopping 63 per cent in the last two, and it now trades on a punchy average forecast PE ratio of nearly 16, well in excess of the market average.

One company whose shares are notably cheaper than the sector average is Britvic. There are good reasons for that. Unlike its peers, the group has found itself unable to capitalise on the inherent strengths of the beverages market. Historic financial problems mean that it has high levels of debt and minimal shareholders' equity. Its shares have been a poor investment, falling by more than a fifth so far this year, not helped by a severe a profit warning in February. We think they'll fall further.

In January, it expressed confidence that it would be able to preserve cash margins based on price increases it had negotiated to cover a 5 to 6 per cent increase in input costs. Only a month later, and sharp increases in the prices of steel, sugar and the plastic PET meant the raw material inflation expectation had jumped to between 9 and 11 per cent for the year, which saw many take red pens to their forecasts for the third time in less than six months.

While some have suggested that the circumstances surrounding that profit warning were bad luck, we'd suggest that the business seriously underestimated the volatility in commodity markets when entering into pricing negotiations with customers. Britvic now says that the worst of the input cost inflation is behind it, and is sticking to its guidance for the rest of this year, and some analysts have concluded that the downgrade cycle is behind us.

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But we're still mindful of the volatility that has caught the company out before, and although the company says that 90 per cent of input cost requirement for the year are covered by hedging and forward buying, beyond that the picture is still uncertain. PET, which is used to manufacture plastic bottles and accounts for around a fifth of Britvic's raw material costs, is closely correlated to the unpredictable oil price. Sugar prices are also heading back towards a record high, because the ouput from key producer Brazil is expected to be lower than expected this year as a result of bad weather.

The group does have scope to make further cost savings to mitigate, especially in France where its targeting €17m of synergies by 2013 from its takeover of Fruite. But there are suggestions that progress there may be hindered by a potential increase on VAT on soft drinks from 5.5 per cent to 19.6 per cent. That could hit demand, and certainly constrain Britvic's ability to push through price increase of its own in a market that's already proved particularly sensitive to input cost inflation.