Mixing Drinks – Not so bad after all!

Mixing Drinks – Not so bad after all!

Today I want to take a look at the beverage sector – a number of have reported results recently. In my humble opinion, in the UK there are a number of high quality operators.

This review was prompted by the following:

  • I want to move more towards quality companies that I can hold over the long term.
  • Given where (I think) we are in the market cycle, I am happy to swap cyclical for defensive.

Sector multiples (per Stockopedia):

  • Median P/E: 24.7
  • Median Div yield: 2.51%
  • EPS Growth Forecast: 8.09%

Not a cheap sector!

A look at the numbers:

Company Name ROCE TTM ROE TTM ROE 5yr Avg Op Margin % P/FCF P/E TTM P/E Forward
Diageo 17.2 34.5 30 32.5 28.5 25 21.9
Coca Cola European Partners 9.6 15 25.5 11.96 16.3 20.5 17.5
Coca Cola HBC 13.1 15.9 12.3 9.1 38.22 24.7 20.9
Britvic 12.8 22.2 41.2 8.4 21.8 13.4 14.6
Fevertree 38.4 36.4 28.8 31 25.7 26.2 26.1
C&c 8.7 13.3 2.4 6 16.7 14.7 13.6
AG Barr 17.3 15.8 19.2 15.3 23.7 21.3 23.1
Nichols 26.5 24.1 28.1 21.47 35.9 19.2 19.3

Interesting that the highest quality metrics are associated with businesses that own their brands, whereas the lower returns are distributors of brands.

This is also reflected in the multiples.

A point to note here is that ROCE includes intangibles and amortisation (many don’t), and if this was adjusted for, Diageo would be a beneficiary – hopefully by including P/FCF, this becomes apparent.

Bearish on Britvic

Of the above, I don’t hold Britvic in high regard compared to the others. Fevertree drank their gin in the UK tonic market, Pepsi which they distribute has been priced lower than Coke consistently (wonder how Pepsi feel about that) and their results are heavily adjusted. Indeed in 2019, adjustments / share were greater than reported earnings per share! (NB: Operating Cash Flow tracks the adjusted earnings, so the adjustments might be justified).

I understand Graham is long this stock. Tony just wrote about it here and I share his bearish view (but do not have a position in it).

Some amazing brands

Diageo has a number one or two position in pretty much any alcoholic spirit you can think of.

Nichols is Vimto, AG Barr is Irn-Bru and Fevertree is, well Fevertree.

From the above, one can reasonably conclude that alcohol is the higher margin business – indeed Diageo’s margins are higher than CocaCola or Pepsi at 23% and 16% respectively.

Recent performance

Nichols share price has been depressed since lowering guidance in December, although the update on 9th Jan was in line with the revised guidance. The share price has been drifting lower which given reduced guidance was with good reason. The catalyst was an announcement about Middle East taxes on the core Vimto product (apparently they love Vimto in the Middle East) and earnings estimates for next year have been slashed.

Diageo has also been trending lower. Most recentl,y JP Morgan issued a note reducing growth estimates because of a slow down in India.

Fevertree disappointed on UK growth and reduced guidance and margins for the US in the near term (which further supports my view that alcohol is higher margin and perhaps a more sustainable margin).

AG Barr announced results yesterday and Graham covered it here – I also have this as a perennial watchlist share and seriously considered buying on the last warning. In particular, the ability to maintain prices is testament to the quality of the brand.

My view

The infinite capital portfolio would be a buyer of all these companies, but given that I don’t have that (yet), my preference would be for Diageo and Nichols.

AG Barr is a wonderful company and has a remarkable position in Scotland (where I understand Irn Bru outsells Coke), but I am not sure how much international reach they have compared to Vimto and indeed Nichols’ other brands such as Sunkist.

Fevertree is tempting given the growth opportunity, but I am not sure whether they will be able to sustain their margins and even with the recent falls, growth is priced in – certainly possible but this comes with execution risk. I would be a buyer at a lower price that better reflects the risk of international expansion not materialising.

Why Nichols?

I have been looking at Nichols and quantitatively I am thoroughly impressed – the fact that its margins and returns on capital match Coke and beat Pepsi shows how well their brands can compete and they have international reach.

Since 2014, its share price has increased from £10 (PE 18x) to £13.50 (PE 18x):

  • Net cash,
  • No shares issued,
  • Positive cash flow in each year
  • 50% increase in Revenue and
  • 66% increase in Operating profit

Due to more recent issues, it has become a bigger business at a lower market capitalisation over the last three years.

If you are willing to look through the short term, I think this is an excellent candidate. I am tempted to open a starter position – certainly in the event of any general malaise as a result of Corona virus (Owned by AB Inbev – the beer not the virus!) or investors becoming more nervous about its valuation. It is very firmly on the watchlist.

Why Diageo?

They are indeed exposed to India and this is one of the reasons I like them. I have been to India three times in the last year: Indian people love their brands and the men especially enjoy their drink, whiskey in my region and always Johnnie Walker or Glenfiddich.

There is a lot of debt, but given the cash generation and relative safety, I think the business can handle the debt load and should management wish, they can reduce share buybacks.

A number of FMCG have reported pressure from private lable (PZ Cussons most recently) but I cannot see this extending to alcohol.

I have tried Tesco & Lidl private label Cola. The Lidl version is great – we drink that at home now!

But I cannot imagine trying a Whiskey, Vodka or Gin, even if it was Waitrose or Sainsbury’s private label (not that I have seen any).

Conclusion

Cash generative, good balance sheets, quality brands with a growth runway.

It is not easy to find quality businesses but I think Nichols and Diageo for the long term patient investor are approaching a reasonable price, indeed relative to the market I would argue they are at a reasonable price.

Now if only Mr Market would say cheers and buy me a drink!

 

 

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  • comment-avatar

    Good, insightful article. Thank you for writing. Quick question – when considering quality beverage companies did you also look outside UK listed? Pepsico (PEP) looks like it’s at an interesting juncture and also holds some high performing snack brand. With beverages disappointing in the past the company has invested heavily to turn them around

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  • comment-avatar

    Thanks Terrry
    I looked at both CocaCola and Pepsi as comparables, but didn’t include in the table.

    Phil Oakley wrote an excellent article on Pepsi, which is well worth a read (registration required)
    https://www.investorschronicle.co.uk/comment/2020/01/22/pepsico-back-on-the-growth-track/

    I would agree it is a great company, trading at a lower valuation than Coke.
    Indeed, the snacks business seems a real star, especially in North America, which is on higher margins.
    My concern would be that they are moving to healthy snacks, which comes with execution risk. I am not sure to what extent they can leverage their existing portfolio, since that would be confusing the brand positioning. I don’t associate their existing brands with healthy eating.
    This cost McDonalds a few years ago when they started marketing their salad offering.

    If I was inclined to invest in US companies, Pepsi would be high on the list – 16x forward and ROE near 100% and 3% dividend – considering the multiples on Nike, Coke, McDonalds, P&G, arguably Pepsi is cheap.

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