Coke (NYSE:KO) has a huge global footprint and a brand presence which is arguably unrivaled in the food and beverage sector. It is estimated that the brand is the fifth most valuable in the world and that 1.9bn cans over 198 countries are sold and enjoyed on a daily basis. The result of this is that coke or a coke brand is the most popular carbonated beverage in every country but one. That country is Scotland and the one drink that is more popular is Irn-Bru made by A.G Barr (LON:BAG) (OTC:AGBAY) (OTC:GRRXF). This was reported in August of this year through the below map being widely circulated:
While grabbing much attention and fanfare, it is strictly not true with North Korea, Myanmar and Cuba not favoring Coca-Cola products (Fact-check).
Despite the fact that the graph was incorrect, the point remains that A.G Barr enjoys a dominate market position in its home nation of Scotland and is starting to make a foray into the rest of the United Kingdom. The main brand of Irn-Bru has similar lines to Coke products (Diet and Extra) and the firm has other brands such as Rubicon, Snapple and Strathmore Water.
Irn-bru maintains cultural significance in Scotland and personally is my favorite drink (being Scottish may bias that, as my American partner cannot stand it). The passion and fervor that the drink has created was shown in 2017 when a change to the secret recipe was announced, the result was people stockpiling the existing recipe and paying up to £52 a bottle on eBay. (Independent) Marketing is one area the firm excels at and has been very successful in recent years with adverts playing on its Scottish routes and despite not having the same international reach as whiskey is just as important within the country.
While A.G Barr has Coke beat in Scotland, Coke categorically destroys A.G Barr in size and market-cap. This firm has a capitalization of roughly £750m and is a member of the FTSE-250. (Small-cap traded on an international exchange which may not be of use of the many readers)
To begin with the share price history has a couple of interesting points of note, the first of which is the relative strength during the financial crisis and how stagnant price has been for the past 4 years. The stability during the financial crisis I would assume would be linked to the low price of the products and the brand strength that A.G Barr possesses. The recent poor performance can be attributed to two factors which will be fleshed out further below in Brexit and the impact of the UK's new sugar tax. The firms P/E ratio is 21 which is high for growth of sub 10% p.a. and the maturity of the brand/sector in which they operate.
Source: Google Finance - (Lon:BAG)
One of the key strengths of Barr has been its strong dividend growth, for which it has a 15 year streak of increasing dividends. The yield at present (17/03/2018) is 1.69%, which is below the 5-year average and can be contributed to the run-up in the stock in the past 1 year from lows of £5 in January 2017 to highs of almost £7 in late 2017. The average annual growth in the dividend has been just under 10% over the course of the 15 years. This is quite an achievement and the firm has not cut a dividend for 18 years.
Authors own chart from data from DividendChampions.UK
The growth of the firm's revenues is the most impressive aspect, as it recoded growth double that of the UK soft drinks market as a whole. (8.6% vs. 4.2% yoy) (Interim 2017 report) This is due to the continual evolution of the brands and offerings that the firm has. From memory they are not afraid to venture into new areas which new entrants dominate. As seen when they released Irn-Bru 32 which was a direct competitor to Red-bull and over high caffeine energy drinks that entered the UK market. This product was eventually discontinued but the evolution of the 133 year old core offering of the firm is integral to their continued success.
The most important change that they are focusing on in the near term is the perceived fight on obesity and sugar in the UK. While sugar on its own is not a direct cause of obesity, high-sugar and high calorie drinks are seen to be part of the problem. This has resulted in Barr changing their recipe as noted above and launched new Sugar-free equivalents in both the Irn-bru and Rubicon brands. As well as the strong product offering the distribution network which is built on the sites around Scotland and Northern England has enabled them to enter into agreements with Snapple (Dr Pepper) (DPS) and Rockstar to distribute their products throughout the UK.
When looking at valuation of the firm a simple dividend discount approach is taken with the following factors, assumed growth of 7% p.a. risk free rate of 0.5% and market performance of 6.2%. The result is a fair price of £5.65 per share, which represents a discount of 13% compared to today's price. From looking at the performance of the stock over the past year it has had a very strong run up without any real catalyst beyond revenue growth which was not met by corresponding profit growth. As will be reviewed below there is also two very large risks overhanging the firm.
The first risk has been touched upon above and that is the new sugar tax which has the official title of "Soft Drinks Industry Levy" and will come into force from the 06/04/2018. It has created a new tax on drinks with more than 5g of sugar per 100ml of 18p per liter and those with more than 8g of sugar per 100ml at 24p per liter. The impact of which would be roughly a 10% increase in price of the average can of soda and up to a 50% increase in cost for a 2 liter bottle. This change has been long in coming into force and in reaction most of the large soft-drink manufactures have been reducing their sugar content in increments over time. Barr is no exception and has reduced the sugar in its normal variety to below 5g per 100ml to 4.7g. This
They maintain that the changes have been small and the overall taste of the product remains the same but the sugar has been halved in the product from 10g. The entire strategy shift from Barr was to have 90% of drinks under the limit but they now expect that 99% will be compliant. It remains to be seen the impact of this move as although it has mitigated the increase in price, it has changed what was arguably an in-elastic product who's customer base would have accepted the rise in price for a product that they love. When the annual report for 2017 is presented in summer 2018 the real impact of the change in recipe will be seen.
The second major risk is the effect of Brexit. For better or worse the impact that leaving the EU has had on British firms remains to be seen in earnest but the short term impact has been a devaluing of the pound and rising inflationary pressures in the UK. This has put cost pressures on Barr as they have noted mainly through FX but risk management systems in place have mitigated early impacts but has the longer term trend in the weak pound continues there will be less ability to hedge at better rates which had been locked in before. The uncertainty is arguably the main point of worry and the continual will they/won't they rhetoric of the UK government needs to be clarified. The EU has been very unreceptive in negotiations and wants Brexit to be unsuccessful to discourage other nations from following suit. If the UK can band together, stop the in-fighting and start to think about life after the EU and see the opportunities rather than the costs then it would be more beneficial. Until then the likes of Barr will face an uncertain future but they are in a slightly privileged position in that most of their revenues derive from the UK.
To conclude A.G Barr is a firm that I have a lot of personal admiration for, due to the product line that they have and my preference for it. However this is hopefully an instance of feelings not impacting investing decisions and seeing that at present despite its impressive dividend growth history it is not the right time to enter a position and waiting for a fall in price to the mid £5 region. The risk around the change to the recipe of the main product is also a factor in my decision to hold off on purchasing A.G Barr.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.