FQVTF - Fevertree Drinks: Continued Growth But Margins Decline

Summary

• Mixer drinks company Fevertree Drinks might have had a bad last year at the stock markets, but things are starting to look up.
• Its growth is sustained in double digits and even with a drop in margins as cost inflation bites, they remain strong.
• Its P/E is higher than that for consumer staples however, and with its key markets headed for recession, it's best to err on the side of caution right now.

The past year was a tough one for the British mixer drinks company Fevertree Drinks (FQVTF) at the stock markets. Its price is down by 61%. In fact in late January last year, the company had seen a sharp plunge when it flagged cost inflation as a risk for 2022 in its trading update. Recently, it has done better, with its price up by 7.5% in the past month alone. FQVTF isn't the only consumer discretionary stock or ADR to gain ground recently. There's clearly a rotation back to beaten-down stocks as the first signs of a cooling off in inflation appear. The question though is, is the inching up in price justified by its fundamentals?

Growing market, strong position

First things first, the cocktail mixer market is growing rapidly. It's expected to grow at a compounded annual growth rate [CAGR] of 8.2% between 2018-2028 to a size of USD 14.6 billion (see chart below). Additionally, Europe, which accounts for over 60% of Fevertree Drinks' revenue, is the biggest market for these mixers, which is a positive. But the US market is growing fast too, which also has expected to see an over 25% share in the company's revenue in 2022. The market alone is expected to grow to USD 8.6 billion by 2030, showing a 9.3% CAGR between 2022 and then.

Underpinning the growth in the mixer market is the expected growth in the spirit market itself. As long as it grows, there's a good chance that mixers will grow along with it. From a 23% share in 2016, the global share of spirits in the alcohol market is expected to grow to 27% by 2026. This growth is expected to be particularly notable in North America, where they are expected to rise to a share of 36%.

The company has already established itself as a leading mixer provider. Early last year, it pipped Schweppes to become the leading tonic water brand in the US. It's also the biggest ginger beer in the country. Further, it has a huge 40% market share in the UK. This gives encouragement that aside from the cyclical fluctuations, that we are witnessing right now, it's poised to grow.

Continued growth, but margins dip

Next, let's look at its financials. The latest numbers available for the first half of its financial year 2022 (H1 FY22) show a 14% year-on-year (YoY) revenue growth. This is a significant come-off from the 36% growth seen in H1 FY21, but that's only because the year before saw some bounce back as bars and restaurants started opening up once again and also because the base was relatively low for the year before.

Its gross margins have declined to 37.4% (H1 FY21: 44.1%) as have its operating profit margins at 10.8% (H1 FY21: 17.8%). This is a bit disappointing but expected considering the inflationary pressures it has faced. Despite the decline though, they still remain fairly healthy. Moreover, while inflation is still quite high, the first signs of its easing are visible. This could be some relief for Fevertree Drinks towards the second half of the year. However, with recessionary conditions expected in its key markets of the US, UK and Continental Europe, it remains to be seen what its revenue growth this year is like. If it slows down too, margins may still not improve.

Good outlook

Its projections for the full financial year already put revenue growth from its UK market at 2-5%, which is a decline from the 6% seen during the first half of the year. This is "as we recognise the risk of softening consumer sentiment in our most mature market.." says the company. Though it adds "...consumer demographic and affordable treat positioning will mitigate the impact."

It does expect momentum to have continued in Europe though. Further, in the US it expects a bump up in revenue as it acquired Powell & Mahoney , another cocktail brand in September last year. As a result, its full-year revenue is expected to be higher by over 15%, which exceeds the growth seen in H1 FY22.

What the P/E ratio tells us

But it's hard to ignore that its diluted earnings per share [EPS] are down by 31% in H1 FY22. And as its price inches up, its price-to-earnings (P/E) ratio is at 32.2x, which is significantly higher than the 21x for the consumer staples sector. That said, it isn't exactly the highest ever that Fevertree Drinks has seen. In fact, over the past decade, its average P/E has been at 62.3x, making it much cheaper by comparison right now.

What next?

There's no denying that Fevertree Drinks has a lot going for it. Its revenues have consistently been in double digits over the past decade, save the pandemic year of 2020. Its gross margin also remains quite high even though it has slipped to sub-50% levels since the pandemic as well. Its operating margin has also been largely over 20%. These reflect the company's positioning as a premium mixer drinks provider with pricing power. And with the likelihood of high inflation coming off to more reasonable levels over the next year, its margins should improve again.

However, for now, the outlook isn't the best for demand with a recession expected across its key markets. It could be a relatively mild recession, but combined with already high prices, it could take its toll on consumer spending. In any other year, it would be a clear buy. Not only does its income statement look fine, but its balance sheet and cash flow also don't have any issues. I'm tempted to put a Buy on it but just to err on the side of caution, it's better to wait for at least its next trading update which is due just a few days from now on January 26 and take a decision then.

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