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Fevertree Drinks - continued strength in the Off-Trade

Nicholas Hyett, Equity Analyst | 14 July 2020 | A A A
Fevertree Drinks - continued strength in the Off-Trade

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Fevertree Drinks plc Ordinary 0.25p

Sell: 2,545.00 | Buy: 2,547.00 | Change -24.00 (-0.94%)
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Fevertree began the year in line with expectations, but since March trading has been "dominated" by the coronavirus outbreak. On-Trade sales, which includes bars and restaurants, have fallen during the lockdowns while Off-Trade, which includes supermarkets and shops, has grown. Management expects some of this growth to transfer back to the On-Trade as pubs and restaurants reopen.

Fevertree has also acquired its German sales agent, Global Drinks Partnership for a total cost of €9.5m. Tim Warrillow said the acquisition provides "an ideal platform to take advantage of the opportunity within the German market and accelerate our growth."

The shares fell 5.3% in early trading.

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Our view

In recent times falling sales in the UK sparked fears the gin boom has turned to bust. Meanwhile guidance for weaker sales in the US and lower margins undermined Fevertree's long term pitch that it can replicate its success across the pond.

However, the disruptive effects of the coronavirus outbreak mean it's difficult to see whether those trends are continuing. The 'On-trade' sales usually make up about 45% of the group's sales and that's where the damage from COVID-19 is being felt. While there's been an encouraging upswing in sales from off-trade partners we can expect an overall fall in sales.

Fevertree has benefited from significant operational gearing during the good times. It outsources most of its operations - think bottlers and distributors - and that gives the group flexibility and makes expansion cheaper. A lean operating model means profits drop straight through to cash to reinvest to fund growth. Unfortunately that works in reverse too. If sales fall, profits will fall by more, and this could be especially unpleasant this year.

The GDP acquisition is an interesting departure from that model.

Management thinks it will be cheaper to buy the current distributor than build out Fevertree's own capacity, which makes sense. It does increase the size and organisational complexity of Fevertree a little, but that's to be expected as the group grows.

However, GDP also generated EUR10m in 2019 distributing third party premium beers and spirits. Fevertree intends to keep doing this, which marks a departure from the existing business model. It's only a small bolt on and to be honest we hope it stays small. It can be risky when businesses divert their attention away from core competencies.

Despite the recent disruption expectations remain high. While year-on-year revenue growth of 9.7% last year would be music to the ears of most consumer goods groups, Fevertree's premium rating means investors demand more of it.

Explosive UK growth is over - there's a limit to how much premium tonic you can sell and it looks like Fevertree is approaching it. In order to keep making progress international expansion is key, particularly in the US. It's a comparatively untapped market, and the group's investing heavily to try and secure a piece of it.

But although Fevertree retains an excellent business model, very strong brand and solid balance sheet, we think the next few years could be a struggle. North American tastes are geared towards dark spirits like Whiskey and Rum. That puts Fevertree's ginger ales and colas centre stage, and the competitive landscape there is crowded. International rivals will have learnt from Schweppes' failure in the UK and be better prepared.

The decision at the full year to maintain the dividend is a major vote of confidence in the coming year, and also reflects a sizable net cash position. However, if the lockdowns are re-imposed pressure could start to mount.

Fevertree key facts

  • Current 12m forward P/E ratio: 53.5
  • Average 12m forward P/E ratio since floating in 2014: 47.0
  • Prospective yield: 0.7%

We've introduced this section in response to recent survey feedback. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Trading update

In the UK Fevertree's Off-Trade sales grew 34% in the 12 weeks ending 14 June. Management attributed this to the increased popularity of long mixed drinks.

In the US Off-Trade sales grew 89% in the 12 weeks ending 13 June according to Neilson data. This reflects greater at home consumption and the additional distribution capacity the group secured last year. Management is also "encouraged" by recent pricing and formatting changes.

In Europe the Off-Trade was more resilient in the North than the South, where bars and restaurants account for a greater proportion of sales and some importers have destocked during the lockdown. In the Rest of the World the Off-Trade has also been "strong", especially in Australia and Canada.

Fevertree expects the disruption caused by the pandemic to act as a headwind to profit margins, but nonetheless intends to continue with planned marketing investments, with £60m budgeted for operating costs this year.

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