3 Reasons Why Fevertree Is A HOLD

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About: Fevertree Drinks Plc (FQVTF), Includes: BTVCF, GRRXF
by: Smart Dividend
Summary

Fevertree still is a great company with great premium products and a recognizable brand.

UK Sugar tax and Brexit fears will weight on future performance.

The company remains too expensive to consider buying at this levels so I rate the stock as HOLD.

Fevertree (OTCPK:FQVTF) is a great company that I have been a huge fan of for the past several years. However, I fear now that the environment has changed significantly for the worse over the past two years and Fevertree has lost some of its attractiveness. Based on future risks I rate the stock as a HOLD.

Business

Fevertree Drinks PLC is a holding company based in the UK. The main business of the company is developing and s upplying premium mixer drinks including Tonics, Ginger Beer, Lemonades and other. The company sells its products to a range of markets, such as the UK, EU and NA where UK currently contributes the majority of the revenues (over 50%).The company sells a wide range of products under the Fever-Tree brand, which include Indian Tonic Water, Naturally Light Tonic Water, Elderflower Tonic Water, Mediterranean Tonic Water, Ginger Ale, Ginger Beer, Naturally Light Ginger Beer, Bitter Lemon, Sicilian Lemonade, Lemonade, Spring Soda Water and Premium Cola. Those products the company sells to hotels, restaurants, bars and cafes, as well as supermarkets all over the world.

Source: Fever-Tree website

Fevertree has achieved some remarkable results in the past as it managed to grow its revenues by more than 40% each year for the past several years. Those impressive results are mainly due to its premium brand which is a clear differentiator from Fever-Tree mass market competition and is a key for both product quality and brand image. Also due to its first mover advantage Fever-Tree has managed to strengthen its position as the global leader of premium mixer drink category.

Thesis

Although Fevertree is still a great company with some premium products and a high-quality brand the stock still remains expensive and I see two more reasons that might push away investors from investing in FQVTF.

1. Sugar tax

As of Friday 6 of April 2018 the UK has introduced a sugar tax which effects sugary drinks. This tax requires shopper to pay up to 24 pence more per litter depending on the amount of sugar in the drink. In other words, customers now have to pay more for their favorite sugar drinks in UK.

Drinks with more than 8g per 100ml face a tax rate equivalent to 24p per litre. Those containing 5-8g of sugar per 100ml face a slightly lower rate of tax, of 18p per litre. Pure fruit juices are exempt as they do not carry added sugar, while drinks with a high milk content are also be exempt due to their calcium content.

Fevertree suffered some heavy damage from the sugar tax as many of the company premium products have a substantial amount of sugar in them. Here are some examples:

Source: myfooddiary.com

We can see the effect of the tax on the company gross margins which dropped from 55.42% down to 50.66% by the end of 2018.

Source: Gurufocus.com

This trend is likely to increase further if Fevertree does not reduce significantly the amount of sugar in its drinks or if it is slow to expand the business in other markets like EU and US. But as of 2018 UK is more than 50% of revenues so it is easier said than done. Also, growth in UK revenues has been 53% by the end of 2018 while US has been contributing to the growth with 21%.

2. Brexit

Many companies around the world are closely monitoring the potential impact and risks of the UK exit from the European Union including Fevertree. As of 2018 more than 20% of the group revenue has been coming from Europe making Europe the second largest market that Fevertree operates in. If trade tariffs are introduced that will further lift the costs and prices for many products and will create a supply chain disruption from more custom checks at borders. Fevertree is currently working with its European importers to ensure they are holding sufficient inventory to be able to absorb any short-term disruption that could occur but this is a short-term solution to a long-term Brexit problem. There is no doubt that in case of Brexit revenues and margins will take a significant hit.

3. Valuations

Since the IPO in 2014 Fevertree shares have been up more than 2000% until September 2018 which is a beautiful growth story. It was no surprise that this growth resulted into extremely high valuations and I have been OK with that for a very long time. The company was in a constant expansion mode with revenues growing over 69% up to 2016.

However now things are a little bit different as growth rate started to decrease in 2017 and reached 40% by 2018.

Source: Annual reports

Investors were no longer willing to pay the high multiples and what happened next was no surprise to anyone. Key multiples like the P/E, P/S and P/FCF fell sharply in the second half of 2018 and continued their fall into 2019 as the share price fell almost 50%.

Source: Gurufocus

The thing that bothers me is that despite the big correction multiples remain high and it seems like the growth rates can fall even further.

When comparing Fevertree to other UK businesses in the soft drink industry FQVTF seems at least twice more expensive than other peers. Several reasons that explain the huge premium are the strong brand, the high-quality product and the rapid growth. Now that the high growth rates are questionable, I expect the company valuation to be much closer to its peers like Britvic PLC (OTCPK:BTVCF), Nichols PLC and A.G. Barr PLC (OTC:GRRXF).

Market Cap (USD)

Revenue growth 2018/2017

P/E (trailing)

P/S (ttm)

EV/Sales

EV/EBITDA

Fevertree Drinks PLC

3B

40%

48.52

12.62

12.62

39.03

Britvic PLC

2B

5%

20.35

1.56

1.97

13.35

Nichols PLC

653M

7%

N/A

2.16

5.21

N/A

A.G. Barr PLC

1B

6%

29.49

3.76

3.76

19.78

Source: Yahoo finance

Balance sheet

The company has a solid balance sheet which means that any expected future downside should be a correction of the long-term trend and not a significant drop although I fear there is more downside to come before the trend is renewed. As of 2018 the company has its cash account growing by 62% and is the biggest item in current assets meaning that the company is well prepared to face future problems.

Source: Annual report 2018

Risks to thesis:

One way for Fevertree to avoid the UK sugar tax is to expand its business fast enough to other countries like it did with its US subsidiary. However, doing so Fevertree will lose its first mover advantage that it had in UK and will have to fight other companies for market share. There is also the possibility that some form of sugar tax to be introduced in other countries too. Free of sugar products or fruit sugar products might help the company to reduce the negative effects of sugar tax.

If Fevertree is able to maintain its high growth rates, higher multiples will be again justified. In the years to come I see Fevertree to shake off some of its past growth.

Brexit remains a highly uncertain event and it seems that it can still go either way so it should be close monitored by both investors and management.

On 6 August 2018 the management sold 3,000,000 ordinary shares due to large institutional demand. Large institutional demand in 2018 was a very bullish sign showing that institutional investors still believe in the long-term potential of the company despite Brexit fears, trade wars and sugar tax.

The company has a solid balance sheet that may make investors unwilling to sell their shares even facing significant risks from outside of the company.

Conclusion

I have been a huge Fevertree fan for several years but now I must rate the stock as a HOLD due to several big risk related to future growth like Brexit and UK Sugar tax. I also fear that valuation is still too high considering the falling margins and slowing growth rate.

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.

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