Soft drink manufacturer AG Barr (LON:BAG) shares today tumbled 30% in early trading as the company revealed that adverse weather in the first half of the year means that profits for the full year will be below expectations. After a couple of months of a gaining share price, the price decline was such that we hit a one-year low:
To be fair, this drop only takes us back to roughly where we were this time last year, although the scale means that a decent amount of value has been wiped off the value of the company.
AG will be a familiar name to many, owning soft drink brands such as Irn-Bru, Rubicon, KA as well as being sole distributor for the Rockstar brand of energy drinks. Some well-known brands here, if not quite at the top-table such as Coca-Cola/Sprite/Fanta.
The drinks market has seen some big changes, relatively speaking. In terms of demand for product, this is about as predictable as you can get: people will continue to want to drink sweet things. But in the past year the government are wanting people to drink less of them, introducing a sugar tax. This gives companies a few options: either pay the tax (by passing it onto customers), reduce sugar, or come up with an alternative for sugar. It is evident that all these options have been taken.
Another potential blot on the horizon for soft-drink makers is Fevertree Drinks, who have come from nothing to be an extremely strong player at the premium end of the market. Not quite competition for AG, but potentially in future could be.
This comes in a trading update ahead of its interim results. Some good and bad news first reflecting on broader market issues in the past year:
As previously communicated, 2018 was an unprecedented year for soft drinks with changing pricing and promotional dynamics in the market following the introduction of the Soft Drinks Industry Levy (SDIL) alongside CO2 shortages and a long, hot summer. Against this backdrop we placed an intentional short-term trading focus on volume which successfully boosted growth and, as updated in March, we have subsequently returned our Barr Soft Drinks business to its long-term value driven approach, increasing price positioning in the market.
On to the trading for the current year which is bound to disappoint holders:
While we anticipated that volume would be impacted by this return to our traditional pricing strategy, trading in the financial year to date has been below our expectations. This has been exacerbated by some specific brand challenges, particularly in Rockstar energy and Rubicon juice drinks, as well as disappointing spring and early summer weather, most notably in Scotland and the north of England, and compounded further as we approach the half year when the prior year comparative weather was at its peak.
Weather seems to be a common excuse nowadays: it does seem that last year was unseasonably hot. The outlook offers no real crumbs of comfort:
Revenue for the 26 weeks to 27 July 2019 is estimated to be in the region of £123m, representing a c.10% decline on the prior year (2018: £136m).
Despite our strong second half plan it is not expected that we will recover fully from the volume impact in the first 5 months of this year and the current trading we are experiencing. As a result, we expect our profit performance for the full year to decline versus the prior year by up to 20%.
It is also anticipated that there will be some exceptional costs incurred in the current financial year as we take action to regain momentum. Further guidance will be provided at the interim results.
Full-year profit last year was £45.1m, so this seems like a very poor half, and assume from the tone of this this will before the exceptional costs bite.
There is no analyst update on Research Tree yet but considering the last one mentioned the share price looked ‘full’ at 730p, there could be a downgrade.
It goes without saying that A.G Barr is a quality business with decent metrics, so it is quite surprising to see it in the profit warnings section. The soft drinks market as a whole is very mature, and their results show that: slowly increasing revenues and profits, all at good margins as a result of strong brands with clear strength. The firm runs with no debt, and it is these type of attributes that have seen it being one of the top holdings for the Buffetology fund – high praise indeed.
Cash conversion here is extremely clean, averaging very close to 100% over the years. As we can see from the inventory turnover ratio (over 10), this is an efficient business, with no heavy stockpile of goods. Things are made, and then they are sold. Accounts receivable and payables have stayed constant over the years indicating no real problems in their cash cycle.
There are a fair amount of intangibles on the balance sheet as a result of many acquisitions over the years. Expansions into new markets often take the form of acquiring other brands or partnerships with other brands instead of AG developing one themselves – a tried and tested formula. Unlike other proprietary assets in other companies, it is easy to see that the brands do have some value. Even excluding this, net tangible asset value stands at over £100m.
Capex requirements have been low relative to the business:
Free cashflow is also positive every year which has allowed the business to pay a progressive, well covered dividend as well as build their cash balances. Acquisitions have been financed with this cash and many are are sensible fit, which has been much better for shareholders. In other firms we may have seen a heavy dilution of shares to fund an over-ambitious takeover of a large target. Management have delivered well and remuneration appears well-aligned.
So all in all, there is no short-term worry here at all.
The report reads here as one of the best, and it is: there is very little wrong with A.G Barr. The weather excuse is plausible enough, and measures are underway which should help mitigate a loss in the long-term. Strategically they are seeking to cover remaining gaps in the market via partnerships and acquisitions instead of betting the house on new product launches.
So really that just leaves one problem, which is the valuation of the company. Before today, AG traded on a huge earnings multiple, in excess of 30 times. Perhaps this is a function of the industry: short of any real mess-ups, there would be a very high certainty that good brands today will still be good brands in the future. But whether this is deserved is another thing. Fevertree trades on a slightly higher valuation but at least in that there is a fair amount of growth baked into the price; there seems to be very little transformational happening in AG, growth is more incremental. There is a fair balancing act between public sentiment turning against sugary drinks, to pushing the product portfolio to healthier alternatives and adjusting the existing brands. It is difficult to see the main brand Irn-Bru be ever associated with health.
And whilst a slightly more complex company with more moving parts and more debt, Coca-Cola now trades on a smaller multiple than AG. In terms of brand name, this is about as solid as you can get. It could even be that AG may make a decent acquisition for them sometime in the future as the market cap could easily be raised by them.
So for my money, its still too expensive, but I can see them recovering in the longer term. 4/5.