Two recent analyst updates from UBS provide contrasting perspectives on the beverage industry, or at least for two of its practitioners, both of which might normally act as consumer defensive options in times of market turmoil. Share prices for both Britvic (BVIC) and Fevertree Drinks (FEVR) have ticked up in the year to date, but the outlook for the stocks differs appreciably. Among several plus points, the UBS analysts highlight the stability of the former company’s earnings, leaving it as “an attractive buying opportunity”, whereas the latter drinks company can only look forward to “margins reaching new lows in 2023”.
It’s difficult to say whether lessons are to be learnt from Fevertree’s fall from grace, especially given that it has been one of Aim’s great success stories. But it could be worth examining whether a contrarian play is in the offing. The premium mixers specialist started trading on London’s junior market in November 2014. And just shy of four years later its stock had risen by 2,241 per cent, a rate of appreciation normally associated with binary-bet stocks, baby-bios, oil juniors, and the like. Was this share price surge justified? Well, the company experienced a near-tenfold expansion of net operating cash flow over the period, along with a commensurate rise in the net margin. The cash flow return on invested capital quadrupled to 28.7 per cent – and investors flocked in on a succession of earnings upgrades.
Tapping into premiumisation
The company was lauded for its capital-light business model and a prescient market perspective, as its high-end mixers tapped into the consumer trend towards “premiumisation”, aptly described as the overlap between the desire for luxury items and the function of the mass market. By early March 2019, when the company announced a 34 per cent hike in reported profits, the Investors' Chronicle noted that Fevertree’s “unfettered commercial success and unconventional business model have posed a challenge for analysts seeking to accurately value the premium mixer brand”. The pandemic and the consequent collapse in the on-trade market put paid to further clarity on the valuation front, at least temporarily. But the rot really set in last year when energy inflation fed through to soaring glass prices, a situation exacerbated by the Ukraine invasion. The company duly trimmed its expectations for adjusted profits and the market took fright.
Many of the problems are down to external factors, but there is at least one variable that could run in the company’s favour, or at least attenuate margin pressure to a degree. Wholesale natural gas prices have been falling more rapidly than energy analysts had been expecting, while northern hemisphere gas inventories are up on the five-year average despite the war in Ukraine. In a recent trading update, the company’s chief executive, Tim Warrillow, ventured that “energy-related cost increases, which are particularly acute across the glass industry... will unwind significantly as the energy price recalibrates”.
Significantly, yes, but probably not as rapidly as he might hope given the lag associated with forward contracts on gas supply. It’s perhaps telling that Coca-Cola Europacific Partners recently told Reuters that glass costs would rise by the “mid-teen to low double digits” this year. Around 80 per cent of Fevertree’s product portfolio utilises glass bottles, so they constitute a greater proportion of overall costs compared with many industry rivals. It’s estimated that the direct energy component of glass manufacturing will equate to £20mn in additional costs through 2023.
Top-line growth
Warrillow also said that the company remains “very confident in delivering strong top-line growth, most notably in the US”. That’s encouraging, particularly given the size of the addressable market stateside, but it’s also slightly at odds with a survey of 3,000 alcohol consumers in the US conducted by UBS, which showed “declining intention to use mixers with different types of spirits, particularly gin, tequila and whiskey”.
Whether a sudden outbreak of temperance will weigh on the share price is difficult to say, but at least the 50- and 200-day moving averages are starting to coalesce, and with the former on an upward trajectory this is a positive sign. And if the historical clamour for the company’s shares was driven partly by irrational exuberance, then who’s to say that the opposing dynamic isn’t now at play. The shares change hands at 51 times forecast earnings and at a 6.3 premium to the consensus target price, so investors haven’t given up on the growth narrative altogether. Yet sentiment is mixed at best. The contraction in the share price through 2022 was in the same ballpark as the projected decline in earnings, but it would make sense to monitor financial updates through this year, as it may eventually transpire that the cash margin projections were unduly pessimistic. Many of the qualities that made it one of Aim's darlings are still evident, but for a consumer stock it was on a particularly lofty perch.
