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Fevertree Drinks - margins under pressure

William Ryder, Equity Analyst | 22 July 2021 | A A A
Fevertree Drinks - margins under pressure

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Fevertree Drinks plc Ordinary 0.25p

Sell: 2,596.00 | Buy: 2,600.00 | Change -69.00 (-2.58%)
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Fevertree's first half revenue rose 39% to £141.8m, excluding the impact of currency movements. This was ahead of the board's expectations, but increased logistics costs have put margins under pressure. The group expects first half gross margins to be around 45% and cash profit (EBITDA) margins to be around 20.5%.

The shares fell 7.3% following the announcement.

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Our View

Before Coronavirus, falling sales in the UK sparked fears the gin boom had turned to bust. 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 too.

However, the disruptive effects of the coronavirus outbreak mean it's difficult to see whether those trends are continuing. Bar and restaurant sales usually make up about 45% of the group's sales and that's where the lockdowns hit hardest. Now that bars and restaurants are opening up again we should expect sales patterns to normalise. We still don't know exactly how this will pan out, but a strong period of summer trading would be a welcome backdrop to the realignment.

In the past Fevertree has benefited from significant operational gearing. 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. When sales slow, the high fixed costs have a significant impact on margins. And margins are also coming under pressure thanks to increased logistics costs.

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 a sturdy 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 to grow the dividend at the full year is a major vote of confidence in the coming year, and also reflects a sizable net cash position. However, if bar and restaurant sales remain subdued or the vaccines aren't as successful as hoped the group's growth plans could be set back further.

It is worth remembering that Fevertree is trading on a very high valuation, which means it's likely to be very sensitive to disappointment.

Fevertree key facts

  • 12m forward P/E ratio: 49.4
  • Average 12m forward P/E ratio since listing in 2014: 47.3
  • Prospective yield: 0.8%

All ratios are sourced from Refinitiv. 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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First half trading update (constant currency)

Fevertree's UK sales rose 4% to £50.3m. The group has seen ''clear signs of pent-up demand'' in bars and restaurants, although this has been tempered slightly by social distancing measures. Sales from shops have remained strong and are roughly in line with 2020 and 17% ahead of 2019. The group's market share has increased by around 1 percentage point to 38.5%, and it retains its position as market leader.

US sales grew 42% to £36.2m, reflecting a 17% increase in shop sales according to Nielson data. Fevertree reported ''strong growth'' in bar and restaurant sales. After winning more new national accounts in 2020 than in 2019, and seeing signs of pent-up demand, management has ''further confidence'' going into the rest of summer.

Total European revenue rose 104% to £41.3m. Life-for-like sales increased 81%, and were driven by importers building stock ahead of the summer. Revenue would have risen by around 30% if last year's destocking is taken into account.

Sales in the Rest of the World grew 71% to £14.0m, although this was around 40% growth on an underlying basis.

Fevertree has increased full year revenue guidance to between £295m and £304m. Full year gross margins are expected to be around 44% and cash profit margins around 20%.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.