Making a decision - Buy in Fever-Tree Drinks

The most difficult decision for an investor is deciding when to buy and sell stock. To commit money to the firm shares, a buy side choice demands a moment of projected truth in the company’s growth and financial performance. However, despite the assumption of thorough investigation and beliefs in the efficacy of the techniques used, real financial commitments include risk aspects. This demonstrates that losing money is a normal possibility, necessitating caution when investing real money to any investment. The sell side decisions are motivated by the quest of making money that should not necessitate making too early sales or late sales. A decision to sell as a loser in the above extremes, results in giving up additional profits though, preferable to not selling in falling prices. Optimizing a buy, hold and sell decision obligates using the price direction indicators (PDI) analysis in itself a reflection of current and projected performance of the company. Applying this investor mentality in Fever-Tree Plc in performing a fundamental analysis of its historical financial data and present performance relative to the industry performance supports a buy decision.

Company Overview

Fever-Tree plc is the leading supplier of specialized premium drink mixers in the world. Founded in 2005 by Tim Warrillow and Charles Rolls, the Southwest London Company provides premium quality mixers (Ryan 2017, p.6). Specifically, its founders targeted the high growth in premium gins and vodka along with the promising rum and whisky categories. The company has taken the carbonated alcoholic spirits by storm to assume top spot by retail sales value in mixer category. A distribution network supports this business model across fifty countries (Ronald 2017, p.6). The Fever-Tree brand was, by late 2016, selling over 14 products in all markets. The company enjoys dominance beyond the UK market being the first innovator in producing premium mixer segment. This enriches the Fever-Tree brand with authenticity, attractiveness and premium provenance amongst trade influencers unlike other mass-market competitors. Fever-Tree mixers have dominated the Outstanding Cold Beverage Sofi awards for three consecutive awards since 2010. The 50 Best Bars ranked its Indian Tonic water product the best selling and most trending in 2016 (Gerrard 2016). Its strong growth prospects witnessed across the four reporting geographies provides investors a buy-in channel in the global premium drinks segment. This has generated a high-flying share price performance in the market since its initial public offering in 2014. Its share is trading at over 98.1 times earnings compared to the 14.7 for rival Britvic. Besides the two have equal market capitalization despite the latter generating fourteen times more revenue (Ryan 2017).

Figure 1 Share chat of Fever-Tree One-Year Performance (Hargreaves 2017)

Fever-Tree Performance Indicators

There is little doubt that the blistering success in its shares price reflects the strong sales performance experienced in both its on-trade and off-trade channels. Since its public offering, investors have enjoyed remarkable capital gains receiving a half-year uplift of 231% closing at 580p from an initial price of 175p in mid 2015(Godbold 2015, p.2). The Fever-tree shows evidence of a racy and high-valued shared unlike the ’jam tomorrow’ speculative stocks. The reason for its sustained toe-curling performance traces to the funders model of creating a premium brand in carbonated misers of alcohol spirits. Today, the share trades at a sell of 1,547.00p and a buy of 1,554.00p for a firm with 0.4 dividend yield and price earning ration of 64.96 (Hargreaves Lansdown, 2017). The performance shows founders selective focus to capitalize on the established trend of consuming premium products. While its high quality mixers cost more than the individual spirits mixed, customers seeks association with the brand by name and accounts. This leaves enable the firm to carve unassailable niche in premium alcoholic spirits by retail sales value for a company started slightly over a decade ago(Godbold 2015, p.6).

While it is unreasonable for investors to overpay for speculative shares, Fever-Tree performance illustrates a reason to buy into its high-rated share. It provides both a boost to growth portfolio and income stocks with its impressive sales and growth results. Encouragingly, the firm reported sales growth across its flavors and formats supported by sustained gains in on-trade and off-trade channels in United Kingdom. Its top line attained 71% increase and 120 basis point improvement in its gross profit margin translated to 82% increase in adjusted EBITDA in 2015 (Stephens 2016, p.2). This performance drew the interest of mass competitors into committed investment in the premium mixers segment. Yet, Fever-tree model shows resilience against struggling competitors such as Britvic eyeing the impressive premium mixers segment (Gerrard 2016, p.4). The Fever-Tree model shows signs of a star stock market performance destined to withstand rivals catch-up strategy.

A reflection of 2016 demonstrates exceptional full-year growth shows strong results in regional, flavors and channels outperforming the forecasted performance. The emphasis of enhancing the market position of its Fever-Tree brand and reputation helped drive the firm into premiumization leadership in transforming the spirits and mixer categories in 2016. The firm reported £35.8m adjusted EBITDA a 97% increase from the £18.2 m reported in 2015 displayed in figure 1. The entry of UK rival group -Britvic, did little harm to its strong revenue generation channels in the premium mixers. Fever Tree posted earned revenue of £102.2m registering a 73% increase from the 2015 £59.3m from 200 million bottles and 27 million 150ml cans consumed in 2016 (Warrillow 2017, p.7). While higher growth rates were attained across formats and flavors, the firm recorded a 118% growth in UK market affirming its continued dominance amidst entry of strong mass-market competitors. The advantageous foreign exchange movement embraced its products as the go-to-choice brand in turn contributing to improving margins. The firm saw its gross profit margin increase by 55.2%, adjusted EBITDA margin at 35.1% and robust net cash increase of £15.3m in 2016 (Ronald 2017, p.6).

Figure 2

Table 1

Year Revenue

(£ Million) % Increase Adjusted EBITDA

(£ Million) % Increase

2013 23.3 6.7

2014 34.7 48.9270386 10 49.2537313

2015 59.3 70.8933718 18.2 82

2016 102.2 72.3440135 35.8 96.7032967

Figure 2 & Table 1 Displaying percentage increase in Fever-Tree full year revenue and adjusted EBITDA results.

Strong Business Model

Fever Tree utilizes its strong business model to win over rivals aiming a share of its high growth premium segment. Being the pioneer in the premium mixer-market segment gives Fever-Tree brand first-mover advantages allowing it to enrich its authenticity as the go-choice for trade influencers and bartenders (Ronald 2017, p.4). The premium provenance enables the firm derives a distinct differentiator in brand image and product quality unlike other mass-market competitors. Besides, its uses a largely outsourced business model supported by a well-established network of suppliers, distributors and bottlers. This generates operational flexibility and scalability without huge capital commitment. The strong relationships with importers and distributors offer its on-trade and off-trade channels sustained supply of its products (Warrillow 2017, p.5).

The firm benefit from diversified revenue streams across channels, customers and geographies. This creates no dependency on single-end unit commands more than five percent of the group revenue (Warrillow 2017, p.5). The alignment of the firms operations around experienced founder-led management and experienced outsourced partners drawn from beverage industry gives the company an edge over late entrants. Blending the latter with scaled outsourcing minimizes capital expenditure in turn generating strong cash generation. The sustained growth in 2016 translated to 72% operating cash flow relative to the adjusted EBITDA with a gross profit margin at 55.2% of revenue (Ronald 2017, p.6).

Applying the five forces analysis model shows Fever Tree competitive position relative to the industry situation. Running the largely outsourced model mandates low capital investment with partners footing their capital requirements. This exposes the firm to suppliers assuming an influential position in its business. The firm counters this by laying down well-established and diversified supplier networks to counter their influence. Fever-Tree benefits from diversified distribution and geographical markets leaving no single customer generating more than five percent of its revenue (Warrillow 2017, p.11). This enables the firm control its prices in the premium mixer segment relative to the quality of product offered. The entry of mass-market competitors’ yields increased rivalry in the mixer category. The firm uses its first mover advantage and established brand to win the category leadership. The mixer category competes for similar customers with long drinks and custom brews, thereby higher substitution threats in the beverage industry. However, the category enjoys monopoly power thereby toning the substitution effect for Fever-Tree. Lastly, the ability of larger investors assembling the industry makes it easier for new entries. Although the industry is unregulated, the resource required to assemble production facilities, distribution network, suppliers and customer awareness are en mass (Stephens 2016, p.3). This keeps the industry experiencing minimal threat of entry, hence beneficial to Fever-Tree business.

Outperforming Forecasts

The founder-management model allows Fever-Tree Plc embrace board-formulated reverse policy approach to outsmart the competitors. This approach allows its products remain competitive by exploiting emerging opportunities while taking on rival strategies. The success of this approach translated to improved gross margin of 3.1% in 2016 relative to the 52.1% earned in 2016. This increase traces to the strengthening Euro and US dollar currency, supportive distribution and efficient production. Moreover, the firm has sustained declining operation expenses. Expenses to revenue generated in 2016 reduced to 20.1% compared to 21.4% in 2015. The positive gains in the spending to revenue earned ratio, emerges from the gearing effect of strong growth in sales despite high investment in systems and organization people. The firm incurred 53% growth in marketing expenses alongside proportional rise foreign currency hedging expenditure.

The expanding revenues trickle down to more income for its owners with both diluted and basic earnings increasing simultaneously. The diluted earnings nearly doubled from 11.48 pence in 2015 to 23.70 pence in 2016 equally noted in basic earnings of 23.86 pence from 11.57 pence in 2015. The improved performance saw the normalized earnings rise by 101.1% from 12.10 pence in 2015 to 24.31 pence while dividends increased from 2.30 to 6.25 pence in 2016. The firm reported nearly tripled its net cash position from £11.6 m in 2015 to close at £26.9m in 2016 (Warrillow 2017, p.11). Following the 2013 arrangement with Lloyd’s capital the firm is able to access over £10m of three-year revolving credit from the Lloyds Bank plc. The strong performance in the UK market boosted the firm’s working capital increasing by £10.2M - 74% relative to the 73% growth in revenue. While the extreme trading performances in the United Kingdom led the elevated trade receivables relative to the 2015 position at 91%, the trend shows likely huge collection of cash balances in 2017 (Warrillow 2017, p.11).

Outsourcing majority of its non-core functions facilitate optimization of capital expenditure. This leaves the firm to focus on territory expansion in European market and the US. This is noted of £0.6m in Germany market on crates to improve transport of reusable bottles. The ongoing strong performance shows a trend of performance indicators outperforming the board expectations. Flagged by the high-growth 2016 period, the revenue grew by 72.5% in 2016 ahead of 70.8%, gross margin by 55.2% unlike expected 52.1% in 2015. The adjusted EBITDA of 35.1% in 2016 was equally higher than the expected 30.7%. This emerged from the towering performance in the UK as its established market, the positive uptake in the continental Europe and in the USA alongside the territorial expansion in the rest of the world.

Projected Performance

Fever-Tree dominance in the premium mixer segment shows signs of growing further given its established low-capital investment model. The focus on expanding core operations and outsourcing non-core activities will enable the firm to boost its net cash position in 2017 and 2018. The strong performance across its formats, flavors and products will likely remain ahead of its expectations in years 2017 and 2018. As Fever-Tree expands its grip in the premium mixer market, it will experience strong growth in net cash position driven by the on-trade and off-trade UK channels (Branchflower 2017, p.3). Besides, Fever Tree is a pioneer brand with leadership across the premium mixer category. Equally, the global opportunity remains large and likely to expand from long-term premiumization of the spirits segment (Branchflower 2017, p.6). The growing preference for mixed and long brands will benefit Fever-Tree products a reason for a confident outlook for the business as displayed below.

Projected Income Statement

2015 2016 Change Rate 2017 2018

Revenue 59,252,617 102,237,354 0.42 145,222,091 206,279,358

Cost of sales (28,377,765) (45,815,263) 0.38 (63,252,761) (87,327,050)

Gross Profit 30,874,852 56,422,091 0.45 81,969,330 119,084,049

Administrative expenses (13,606,120) (22,049,714) 0.38 (30,493,308) (42,170,245)

Adjusted EBITDA 18,182,469 35,838,989 0.49 53,495,509 79,850,731

Depreciation (123,924) (249,318) 0.50 (374,712) (563,173)

Amortization (720,000) (720,000) - (720,000) (720,000)

Share based payments Charges (69,813) (497,294) 0.86 (924,775) (1,719,725)

Operating Profit 17,268,732 34,372,377 0.50 51,476,022 77,090,416

Finance Costs -

Finance income 27,970 79,821 0.65 131,672 217,205

Finance Expense (536,189) (150,318) (2.57) 235,553 (369,119)

Profit before tax 16,760,513 34,301,880 0.51 51,843,247 78,354,955

Tax Expense (3,429,730) (6,804,222) 0.50 (10,178,714) (15,226,755)

Profit for the Year 13,330,783 27,497,658 0.52 41,664,533 63,130,224

From the basis of the previous performance, it is evident that the highly outsourced model will likely result in similar low capital investment. From the transitivity theory, the high revenue generation will result in strong revenue generation. Using the previous year trend, a high net cash flow for Fever-Tree is projected derived from sustained star performance in the premier mixer category as shown below.

Projected cash flow

Year 2015 2016 2017 2018

Profit before tax 16,760,513 34,301,880 51,843,247 78,354,955

Finance expense 536,189 150,318 235,553 369,119

Finance income (27,970) (79,821) 131,672 217,205

Depreciation of property, plant and equipment 123,925 249,318 374,712 563,173

Amortisation of intangible assets 720,000 720,000 720,000 720,000

Share based payments 69,813 497,294 924,775 1,719,725

18,182,470 35,838,989 54,229,959 81,944,176

(Increase) in trade and other receivables (8,405,952) (13,596,495) (21,992,117) (35,571,902)

(Increase) in inventories (2,030,505) (4,147,081) (8,469,952) (17,298,937)

Increase in trade and other payables 5,143,693 7,585,088 11,185,263 16,494,220

(5,292,764) (10,158,488) (19,276,806) (36,376,619)

Cash generated from operations 12,889,706 25,680,501 34,953,153 45,567,557

Income taxes paid (2,534,707) (5,047,888) (7,532,248) (11,267,798)

Net cash flows from operating activities 10,354,999 20,632,613 27,420,905 34,299,758

Investing activities

Purchase of property, plant and equipment (361,635) (823,011) (1,053,454) (1,348,421)

Net cash used in investing activities (361,635) (823,011) (1,053,454) (1,348,421)

Net cash used in financing activities (1,935,653) (4,487,401) (5,923,369) (7,818,848)

Net increase in cash and cash equivalents 8,057,711 15,322,201 20,444,081 25,132,490

Cash and cash equivalents at beginning of period 9,583,313 17,641,024 32,963,225 53,407,306

Cash and cash equivalents at end of period 17,641,024 32,963,225 53,407,306 78,539,796

Conclusion

Fever-Tree Plc is destined to experience continued leadership in the premium mixer category. The projections above shows continued dominance set to expand its net cash flow position and profit making. A buy decision would suit an investor seeking long-term capital gains via a thriving leading star in a segment in its early days. Its strong growth prospects witnessed across the four reporting geographies provides investors a buy-in channel in the global premium drinks segment. A buy decision for its stock shows positive signs to an investor seeking high growth segments.

References

Branchflower, A. (2017). Fevertree Drinks plc (“Fever-Tree”) Trading Update. [Online] Available at: HYPERLINK “http://fevertree1.d3r-cdn.com/pdfs/original/2124-ft-pre-close-trading.pdf” http://fevertree1.d3r-cdn.com/pdfs/original/2124-ft-pre-close-trading.pdf [Accessed 10 April 2017].

Gerrard, B. (2016). Competitors struggle to take the fizz out of Fevertree. Investors Chronicle, 26 July.

Godbold, K. (2015). Can Fevertree Drinks plc Beat Royal Dutch Shell Plc In 2016? [Online] Available at: HYPERLINK “http://www.fool.co.uk/investing/2015/12/09/can-fevertree-drinks-plc-beat-royal-dutch-shell-plc-in-2016/” http://www.fool.co.uk/investing/2015/12/09/can-fevertree-drinks-plc-beat-royal-dutch-shell-plc-in-2016/ [Accessed 10 April 2017].

Hargreaves L. (2017). Fever-Tree One-Year Share Performance. [Online] Available at: HYPERLINK “http://www.hl.co.uk/shares/shares-search-results/f/fevertree-drinks-plc-ordinary-0.25p” http://www.hl.co.uk/shares/shares-search-results/f/fevertree-drinks-plc-ordinary-0.25p [Accessed 10 April 2017].

Ronald, B. (2017). Chairman Report: Fever-Tree Drinks PLC Annual Report and Financial Statements for the year ended 31 December 2016. [Online] Available at: HYPERLINK “http://fevertree1.d3r-cdn.com/pdfs/original/3094-fevertree-ar-2017-web-ready.pdf” http://fevertree1.d3r-cdn.com/pdfs/original/3094-fevertree-ar-2017-web-ready.pdf [Accessed 10 April 2017].

Ryan, C.( 2017). Fevertree Turns to Dark Spirits to Sustain High-Flying Shares. [Online] Available at: HYPERLINK “https://www.bloomberg.com/news/articles/2017-03-17/fevertree-turns-to-dark-spirits-to-sustain-high-flying-shares” https://www.bloomberg.com/news/articles/2017-03-17/fevertree-turns-to-dark-spirits-to-sustain-high-flying-shares [Accessed 10 April 2017].

Stephens, P. (2016). Will Diageo plc, Fevertree Drinks PLC & Britvic Plc Beat The FTSE 100 This Year? [Online] Available at: HYPERLINK “http://www.fool.co.uk/investing/2016/03/14/will-diageo-plc-fevertree-drinks-plc-britvic-plc-beat-the-ftse-100-this-year/” http://www.fool.co.uk/investing/2016/03/14/will-diageo-plc-fevertree-drinks-plc-britvic-plc-beat-the-ftse-100-this-year/ [Accessed 10 April 2017].

Warrillow, T. (2017). Annual Report and Financial Statements for the Year Ended 31 December 2016. [Online] Available at: HYPERLINK “http://fevertree1.d3r-cdn.com/pdfs/original/3094-fevertree-ar-2017-web-ready.pdf” http://fevertree1.d3r-cdn.com/pdfs/original/3094-fevertree-ar-2017-web-ready.pdf [Accessed 10 April 2017].