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Fever Tree – a lesson in glamour

Knowing when to sell a stock which has been a star performer is a critical skill. Robin Hardy examines Fevetree's rise and fall to provide a lesson for investors
Fever Tree – a lesson in glamour

A ‘glamour’ stock is one that has a high price and almost always has a high price/earnings (PE) ratio (or your preferred valuation metric) because of abnormally high investor demand. Glamour stocks also have a habit of creating their own share price momentum or ‘lift’, leading the share price, and valuation, to giddy heights. Most often, the share price, business prospects and earnings per share (EPS) growth become increasingly divergent over time. Investors can make high returns in such stocks, but at high risk and usually without any meaningful dividend yield.

A well known and widely held such stock has been premium drinks manufacturer Fevertree Drinks (FEVR), maker of high-end tonics and other mixers. Founded in 2004, the business enjoyed spectacular early success, achieving high rankings in the Sunday Times Fast Track 100. In March 2013, its value was £48m (via a 25 per cent stake purchase by Lloyds Development Capital) and 18 months later on its Aim IPO this had increased to £112m: by the end of the first day’s trading this had jumped to £138m. Thereafter, the share barely paused for breath in four years climbing 30-fold to a valuation peak value of £4.5bn. This made it the largest stock on Aim and larger than several in the FTSE100. 

At its 2018 high point , however, the shares were expensive relative to the market on a year one PE ratio of more than 70 times. Growth had been impressive with EPS doubling in 2016, rising more than 60 per cent in 2017 and heading for 35 per cent in 2018. But growth and ratings were out of sync at this stage. An ultra high rating is fine if the growth is reliable, but there were signs of growth slowing: this finally manifested in FY2019 with a slight fall in EPS (5 per cent) as the core UK market had all but stopped growing. The shares had already thrown into reverse following September 2018’s half-year results and the rot set in to the share price. Even before Covid hit, Fevertree's shares had fallen by almost two-thirds, and when the dust had settled after the March 2020 Covid slump, the shares bottomed out at less than a quarter of their 2018 peak.

 

 

The reason for such a large fall is twofold and is typical for a glamour stock:

The rating and prospects must ultimately align – while the PEG (PE to growth rate ratio) is an often unhelpful tool for picking stocks, it does ultimately have its heart in the right place. How well a company grows relative to the market rate of growth sets the fair valuation, either PE or EV/Ebitda. Where PEG falls down is in assuming that growth rate should equal the PE – so a PEG of 1 is correctly valued, below is cheap and above that, expensive. By its peak, a PE above 70 times and earnings losing forward momentum were uncomfortable bedfellows.

Explosive build up of risk – the longer a share price and the underlying fundamentals diverge, the greater the build up of risk. It is almost inevitable, like over-inflating a balloon, it will go pop. There is increasing danger of an ‘Emperor’s new clothes’ momentum when someone (a prominent newspaper or well-regarded analyst) points out the Emperor (or business model) is naked, questions the valuation and highlights far better alternatives. The nakedness at this stage was plain to see in the published results.

 

 

Living with glamour

Investing in glamour stocks such as Fevertree is fine as long as one is aware of the higher risk, accepts that the very strong share price performance will ultimately prove to be an anomaly and you are more critical/cynical than normal about the share price versus the business fundamentals. 

Critical evaluation – a company may be exhibiting strong trading today and that will support a higher rating and rising share price but very few, if any, businesses are capable of very rapid growth in the long term. When something looks like a glamour stock, investors should be more critical and questioning than normal – how strong is the growth momentum, when will growth decay to a market average, will the business stop growing and become cyclical, when does it get replaced with the next big thing and when does its key driver or drivers commoditise?

Growing into the rating – a higher equity valuation is fine, but there must be a clear path to how and when that substantial premium will tend towards the market or sector average (some sectors are almost perpetually above or below the market). Before Fevertree fell, the PE and growth rates were moving in opposite directions. 

Momentum – glamour stocks tend to create their own momentum investment, drawing in investors based on historic performance. Demand from momentum investment typically drives share prices up simply because of supply/demand imbalances that decouple the share price from business performance – this is rarely sustainable for long. Shares should be purchased because they have a unique and positive USP, they are consistently beating market expectations, because key drivers have become more favourable and, most importantly, because there is evident value. Momentum is a trading strategy, not a long-term buy-and-hold strategy. 

Momentum can also be a telltale using a tool such as the moving average convergence divergence (MACD). Plotting the 50-day moving average and the 200-day moving average against the share price can often give an early warning sign of a future share price reversal. 

Don’t fall in love – this is a serious danger for investors and can lead to keeping an investment for too long. Shares really should only be retained if they still offer value or some other external factor (ie, tax or regulation changes) is going to drive them up. Once that value or driver no longer exists, it is time to exit and look for the next investment. Glamour stocks have a nasty habit of beguiling investors to stay or to keep coming back but such emotional investment is risky. 

Timing – A vital skill when investing in glamour stocks is knowing when to exit. When an investor has already made a considerable return but believes that more money could still be made, that is the time to exit. If one waits until the news that is going to pop the balloon breaks, the shares will have already dropped. Should investors buy back in on a secondary rebound, such as Fevertree’s in 2019? It is wise to be cautious as this can easily be what brokers call a 'dead cat bounce', a 'suckers’ rally' or 'catching a falling knife' which reflects a short-term pick up in a fundamentally negative share price trend. 

 

Fevertree today

Despite taking a considerable hit to its more lucrative ‘on’ trade (sales made within licensed established such as pubs and clubs) during the lockdown across many of its operating territories, Fevertreee’s recent profitability has proved remarkably robust. This shows that this is a well-run business with a strong market position plus as an ‘asset light’ company (manufacturing is largely outsourced and the group only has 135 employees) it is a very agile business. 

The key mixers market looks to have recovered well and indicators such as the CGA Business Tracker from Peach Coffer report that sales are within a hair’s breadth of pre-Covid levels. Indeed, in September 2021, they were up  8 per cent (and 42 per cent above 2020). Notably, this pick up has been driven more by value than volume, a positive for premium brands such as Fevertree. 

Disposable income globally has been boosted by working from home and this looks generally to have bled into consumer spending more by value than volume (people are trading up). Can this momentum be sustained as the additional disposable income ebbs away? There is likely to be another shift from ‘off’ to ‘on’ sales, which may dent revenues but margins should improve. But will consumers stick with premium brands or circle back to cheaper brands (such as Schweppes)? 

Also, in its heyday Fevertree had more limited competition at the premium end of the market but that space is today more crowded with the likes of Fentimans, Double Dutch, Bemondsey and Yorkshire Tonic all proving very popular. Fevertree is more international (only 41 per cent of sales are from the UK) and shows particularly strong growth in the US and China. All told, it feels likely that Fevertree should be able to deliver the growth that the market expects. 

 

Should investors have another look at Fevertree?

Should investors look to buy Fevertree now, still almost 40 per cent below its peak? Probably not, at least not yet. While the market trends are still favourable, management is still innovative and there is decent enough growth, the rating is still high – the PE at 55 times (see Figure 5) is still over four times the average for the FTSE 350 index. That said, the Beverages sector within the FTSE 350 is rated higher than the market overall, with a year one PE of 25 times against the market’s 13 times. EPS growth for the sector averages 12.5 per cent against more than 20 per cent for Fevertree, so there are grounds for a premium over its peer group but more than double the PE, which is a greater premium than when growth was considerably higher? That feels like a big ask and on a PE of 55 times Fevertree presents as a glamour stock but where much of the glitz has faded. This higher rating introduces more risk as any slip up or set back is likely to see the share price punished. Many businesses are being impacted by supply chain issues and, more specifically, container costs (glass bottles and aluminium cans) are being pushed up by higher gas prices. Fevertree cannot be immune from that. 

It is worth looking at analysts’ recommendations on this stock. Factset logs 14 recommendations: six are ‘buy’, five ‘hold’ and three ‘sell’ with an average target price some 9 per cent below the current share price. Analysts generally lean more to the positive: Peel Hunt, for example, has 82 per cent of its recommendations at ‘buy’ or ‘add’, only 2 per cent ‘reduce’ and no ‘sell’ recommendations. This makes the consensus view on Fevertree unusually skewed towards the negative. 

Is Fevertree still overpriced? It certainly feels that way and, even standing so far below its peak on share price and valuation metrics, it does not feel especially good value. There is a lot more risk than the valuation suggests but this is a strong business and if the shares were to drift closer to the 2,000p level (as they have four times in the last year) they would be more attractive but even then there is better value to be had elsewhere.