Big news from the large-cap world today as shares in Fevertree Drinks (LON:FEVR) slipped by 25% as the premium mixer giant reported a slowdown in UK sales and a warning for profits next year:
The share price movement offers some sobering lessons for investors. Just over a year ago at the end of 2018, both this and Games Workshop were flirting with the £40 region for their shares. Both had some similarities: companies growing at a fast rate with products with high margins that had great positions in the market.
Fevertree has more than halved at this time, whilst Games Workshop has continued to grow. Indeed, the GAW share price has exceeded £70 at the current time of writing.
This is one of the pitfalls of investing in growth companies: the share price already reflects some of the future results. If those results are not hit, the share price can easily be derailed. On the flip-side, for those invested early in Fevertree, the rewards have been immense, and those in at the start would have seen 10 or even 20 times their initial stake.
What’s gone wrong at Fevertree Drinks?
The bad news comes in a year-end trading update. Numbers come first, which is excellent, and these do the talking:
The bottom line growth is 9.7%, and this is one of the points that may have spooked investors, having become used to growth rates of several times this in previous years. Another point was the decline in sales of the main UK market: have we reached saturation point here? To be fair the lack of growth here is not a new thing and was referenced in the half-year update in July 2019.
Fevertree disagrees, and cites poor consumer confidence, although did not blame the General Election (like City Pubs did in their profit warning).
The US showed a marked improvement but also comes with some bad news, as growth forecasts are slashed for the next year due to increased spending costs.
This has had an effect on the whole company:
Despite the softer trading than expected in the final months of the year, we have continued to invest behind the brand for the longer term, most notably in our growth regions. As a result, margins have ended the year behind our expectations and we expect earnings to decline by c.5% when compared to 2018.
It is fair to say this was not expected by the market. There are no recent broker notes on Research Tree, but Stockopedia estimates 2019 earnings after tax at £64m, which is an increase on the previous year. It would be a fair guess that the sell-off also reflects the fact that future years will also be revised downwards as the reduced margins bite.
Fevertree Drinks: Growth at an unreasonable price
Not every company that issues a profit warning is a bad one, and Fevertree is an example of this. As a business, it is superb and is a great case of a successful disruptor. For those uninitiated, it offers premium mixer and standalone drinks. For many years this was dominated by the large carbonated drink brands (Coca-Cola via Schweppes), but Fever Tree have come to dominate the premium category now. Stealth and speed have been its advantages here, and the growth has been colossal: since 2013 it has grown sales over 10 times:
And as we can see from the profit line, unlike other firms wanting to force they way into a market, they have not had to undercut competitors: margins are extremely high, ahead of other soft drink manufacturers. It is only now that we are seeing some kind of competitive response: Coca-Cola have recently brought out a range of ‘Signature’ mixers which may induce some kind of price war.
Other aspects of the business are pleasing as well. Fevertree are extremely cash generative, perhaps due to the relative lack of complication in the business. Once drinks are produced they simply have to be sold, and there is little else needed in terms of customer support. Allied to very low capitalised costs, there is no net debt, and the latest cash balance comes in at £128m and this after paying a token dividend.
Management here are obviously competent, having driven the business through a terrific period in a responsible fashion and are not earning excessive wages despite the market cap of the group exploding upwards to exceed $4bn at one point.
So all in all, this is a terrific business, but the only thing keeping investors out is the price. A quick look on Stockopedia’s charts tells us that the earnings multiple has been volatile but always expensive. In 2019, the low was 31.9 and the high 61.8! Even after todays warning the ratio has dropped only a little to around 28. That is still seriously expensive relative to the profits it is booking.
The bull case, of course is that Fevertree has a huge growth runway. Mixer drinks can be sold in virtually all countries over the world with little or no customisation required. It can also benefit from trends in drinks, for example how gin has become increasingly popular in the UK. It is also fairly easy to position as a premium brand. Coca-Cola is clearly more well known but as a commodity may find it harder to justify premium status.
Are Fevertree shares good value?
This is not an easy question to answer. The case in the UK has been already well-known. Fevertree has quickly become the market leader, and with a share of almost half the market, it may be difficult to maintain the rates of growth seen previously. With alcohol consumption arguably falling, growth may lie in new products.
There clearly is plenty of growth in the US and it appears that this is the next real driver for growth. Efforts have been put in here to really get a foothold in the market, with the company taking charge of distribution here instead of leaving this to the middlemen. Yet the profit warning today implies that there are some headwinds in this area and that perhaps the brand has some way to go to be perceived in the same way as the UK. A look at the Coca-Cola response suggests they are keen to break this dominance (issuing coupons for free samples), and it may be the same on other battlefields.
It is a great business which is going very well at the moment and has no problems with the balance sheet. I still think this is quite expensive and it will be interesting to see how this years overseas sales fare – any more slowdowns in the US rate could see the share price fall further. That being said, I do think at some level this would make an excellent acquisition for one of the larger drinks companies who may believe they could really drive efficiencies with their superior distribution channels. So whilst this is still above my own target price this factor introduces at least some margin of safety. It seems pretty inconceivable to me that the share price could halve from here without being taken over. 4/5.