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Why the fizz may be leaving Fever-Tree

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Why the fizz may be leaving Fever-Tree

With revenue growth of 84%, 118% and 96% over the past three years respectively it is small wonder that Fever-Tree has been a firm favourite with small cap managers.

The stock’s impressive growth, consistently beating conservative analyst forecasts, has been driven by the company capitalising on the trend towards premium spirits in the UK.

‘Fundamentally, Fever-Tree’s success is down to the quality of its products. With many other mixers having moved to cheaper formulations there was a clear gap in the market,’ said Matthew Hoggarth, head of research at Thesis Asset Management.

‘Growth in the UK must slow, with the company having already taken a 39% value share of the market for mixers. However, the UK represented 52% of revenue in 2017, so the potential for international expansion remains significant.’

Others believe that the company still has scope to increase its domestic sales, with Abby Glennie, manager of the Standard Life Investments UK Opportunities fund, backing it to continue growing both at home and abroad.

‘Fever-Tree continues to outperform expectations consistently and people keep saying that it has such a large market share that it can’t grow at the same pace. However, what they fail to recognise is that the UK market for premium mixers is still not mature and it’s still growing. Now with most of the company’s earning upgrades over the past two years coming from growth in the UK business, this is significant,’ she said.

She also notes that the premium mixers market is still in its infancy in the US and the company has been investing in the business, looking to tap into this lucrative market.

This investment has been ramped up markedly in the last six months, with Fever-Tree setting up an office in New York and taking distribution in-house.

‘With its value becoming a little bit more apparent globally, we think based on their record to date that management are likely execute its US strategy well,’ she said.

What about the valuation?

The company’s strong growth over the past few years has certainly been reflected in its share price, which has risen twentyfold over the past five years. Such has been the rise, it is now trading on an eye-watering multiple of 62 times earnings.

So have investors now looking at the stock missed the boat or has the story got further to run?

Phil Carroll, a research analyst at Shore Capital, downgraded Fever-Tree from buy to hold in March on valuation concerns.

‘Whilst we continue to like the business proposition and potential, we are finding it increasingly difficult to justify the valuation at present,’ he said

‘While the growth prospects remain strong, we believe they are captured in the valuation.’

The price surge has also seen a number of fund managers trim some profits from their holding while maintaining a portfolio position.

‘We first bought the stock three years ago at £4 and added some more a few months later at £6,’ said JP Morgan Claverhouse investment trust manager William Meadon.

‘We have recently top-sliced a few shares at £30 to ensure that the company doesn’t become a disproportionate amount of Claverhouse. We still view the shares very favourably and Fever-Tree remains Claverhouse’s biggest active position against the index.’

Eustace Santa Barbara, co-manager of the Marlborough Special Situations fund, has taken a similar approach, saying the company’s fast growth means that the fund sold part of its holding to maintain portfolio diversification

He said: ‘We’ve sold some of our shares, but that was portfolio management discipline on our part, rather than a judgement on the company’s prospects. Diversification is key to our investment strategy and even our largest positions are very rarely more than 2.5% of the overall value of the fund. Fever-Tree’s share price had risen so far that our position was testing that upper limit, so we trimmed our holding. However, it remains a top 10 holding.’

More to go
That said, Santa Barbara expects the company’s earnings multiple to fall in the future as it earnings growth begins to slow.

‘One of the drawbacks of the P/E multiple is that it can make a company growing earnings at a higher rate, like Fever-Tree, look expensive. That’s because this measure most commonly focuses on earnings for a short-term horizon, typically one or two years, rather than taking into account the profits a company like Fever-Tree is expected to achieve over the longer term,’ he said.

‘Looking forward though, as Fever-Tree’s earnings grow this should bring down the P/E multiple and over the long term, probably five to seven years, it should reach a level similar to a company like Coca-Cola, which is growing its earnings more slowly.’

The high valuation has not put off all investors, with Thesis’ Hoggarth revealing that despite its high valuation, the asset manager added Fever-Tree into its AIM portfolio service when it launched it last October.

‘Although the valuation is high, this is justified by the rapid growth which we expect to continue, together with the company’s high margins, its asset-light business model and the significant momentum behind both the share price and the product’, he said.

‘P/E ratios are always useful. Just because they make uncomfortable reading is no reason to ignore them. When you buy an expensive growth company you need to be aware just how much of what you are paying is not for what the company is today.’

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