This year, Fever-Tree (or Fevertree Drinks plc as the company is named) became the largest firm on the AIM segment of the London Stock Exchange. It was one of our most popular stock requests and the first AIM stock we added to Freetrade. If you haven’t tried the app yet, find out more here.
Not too surprising: Fever-Tree has performed exceptionally across its short time as a public company, with its share price multiplying nearly 20 times.
However, though a popular stock, it’s also a highly valued one with a PE ratio of around 50-60 as of 08/05/19. So with a current market cap of nearly £4b, can Fever-Tree continue to fizz?
Note there will be the odd joke about bubbly investments etc. We’re all going to have to live with that.
What is Fever-Tree? 
Fever-Tree is a beverage producer and distributor, specialising in premium mixers for spirits. Their first product and namesake is tonic water but their range also includes lemonades, ginger beer and ale, cola and soda water, as well as variations on their tonic water.
The company was launched by Charles Rolls and Tim Warrilow as a boutique drinks firm way back in 2004. Over the last 15 years, they’ve risen to become one of the world’s strongest premium food and drink brands.
Rolls was a veteran of the drinks industry and previously owned Plymouth Gin. Warrilow was a young advertising executive who initially contacted Rolls to partner on launching a new gin. That would have been a good idea - the premium gin boom was just starting to take off.
When they met Rolls suggested a better one: why launch a gin to stand on a shelf with 10 others when you could sell the sole product that goes with all of them: tonic water? With drinks tastes and culture rapidly upgrading, the market was ready for a more curated, special product than the ubiquitous Schweppes.
The two then travelled across continents to taste and source a huge range of ingredients - quinine from the Congo, bitter oranges from Mexico - to perfect their first tonic water and bring it to market.
Their initial inkling proved very profitable, as the gin market massively expanded over the next decade, with hundreds of new gins launched. During that boom, Fever-Tree was one of the biggest winners.
While the gin market remains fiercely competitive and arguably saturated, Fever-Tree is by a long way the UK’s pre-eminent premium mixer brand in both the on-trade (bars, restaurants etc.) and the off-trade (retail, supermarkets). In fact, by value of sales, Fever-Tree is the number one mixer in supermarkets across the board!
In 2014, the company listed on AIM and since then it’s grown swiftly. With the share price around £31 as of 06/05/19 and a market cap of around £3.7B, it’s grown by about 20x from its £1.65 launch price and become one of the UK’s biggest success stories over the past few years.
Financials 
Diving into their most recent financials, Fever-Tree had a strong 2018. Across 2018, Fever-Tree delivered these figures:
Revenue: £237m
Operating profit: £75m
Post-tax profit: £62m
Revenue growth: 40%
That hefty revenue growth was supported by continued strong performance in the UK (53% sales growth) and further inroads into the huge US market.
The company carries bank and other creditor debt of around £6m - relatively insignificant for a firm of this size.
The company achieved a healthy gross profit margin of 51.8% and EBITDA margin of 33.1% in 2018. That compares nicely to an industry average of 45% and 14% respectively.
Risks 
The company outlined some of their key risks in the annual report Some of these include:
- Supply chain disruption
Premium products need premium ingredients, which are usually in short supply. The more product you make, Managing these chains
- Currency risk
Since the company sells their product and buys ingredients in lots of different markets, they have some exposure to the changing values of foreign currencies. Like many firms with global supply chains, they hedge against this with a combination of financial instruments (futures contracts etc.), as well as other strategies and the ebb and flow of their foreign currency expenditure vs their revenues.
- Competition
The company mentions competition as an ongoing potential risk, although noting that they’ve faced robust competition throughout their history and continued to grow.
That’s pretty much accurate. While a few premium soft drinks brands have launched, there are very few that have achieved the international reach or brand credibility of Fever-Tree. The closest UK competitor is likely Fentimans, but they have nowhere near the same scale.
Clearly conscious of its sleeker rival, Schweppes recently released a premium tier: Schweppes 1783. Frankly, the product itself doesn’t look that impressive and likely won’t challenge Fever-Tree head-on for credibility or quality perception.
However, Schweppes, as part of beverages giant Keurig Dr Pepper and a distribution partner of the Coca Cola Company, can bring a lot more pressure, as well as incentives, to distributors and hospitality chains to stock their competing brands.
The food and drinks market is full of examples of big brands who wake up to new competition, pile a lot of money into cloning it and seize a lot of oxygen from their disruptors. Usually only very high quality brands with strong customer relationships can survive this.
Other potential risks noted in the annual report include loss of key management, supply chain disruption and general economic malaise (both based on Brexit).
Aside from the report (which you should read - it’s a nice annual report), we were also struck by these further potential risks.
Dependence on gin? 
The spirits market is extremely trend-driven. Gin has been flying high for years and continued to grow fast in 2018, but with a hugely saturated and a long period of growth, some analysts are pointing to a moment of peak gin. The company hasn’t broken down their sales by product, but it’s safe to assume that the biggest seller is currently tonic water. If gin sales start to slow, tonic water will likely slump with them.
That potential risk almost certainly factored into Fever-Tree’s product portfolio as they quickly brought out ginger beers, sodas and lemonades to pair with vodka, rum and tequila (Moscow Mules - vodka and ginger beer - were the hot drink in the US for 2018).
The portfolio continues to grow with new tailor-made products and variations. So as long as the premium spirits sector continue to grow, Fever-Tree have a good chance to grow alongside it.
A quick note here: although product variety is generally a plus as it opens up your brand to more potential buyers, Fever-Tree do need to take care not to expand their range too enthusiastically.
More variety means more manufacturing complexity and cost. And at some point extra choices don’t create new sales so much as they just splinter the sales you would have had anyway.
Brexit 
Their currency hedging will help the company cope if a sterling decline causes their ingredients to become relatively more expensive in pounds.
However, if Brexit were to depress luxury or discretionary spending in the UK that could see a brake on UK growth, particularly in the on-trade.
The European portion of their carefully nurtured supply chains will also be put under pressure by a hard Brexit.
That said, the company weathered the 2008 financial crisis while continuing to grow (albeit from a much smaller base).
With regard to the risk of Brexit disruption, it’s hard to see how any supply chain dependent UK company could come out unscathed from a chaotic Brexit. However, Fever-Tree have been pursuing a plan to mitigate the risks.
Is Fever-Tree simply overvalued? 
This is the crux. Fever-Tree has a lot going for it as a business: a quality brand, few rivals, high consumer appeal and favourable market dynamics.
But by traditional industry standards and metrics, the company is pretty expensive and there is a fear that the stock has already tipped into a bubbly valuation - even with the company having fallen from its mid-2018 peak.
A lot of sceptics might say: “hey, they just sell sugar and water - why pay so much for that company (or a gin and tonic)?” However, Fever-Tree created a strong enough brand to successfully charge a big premium on sugar and water (plus a few flavourings). They’ve also managed to sustain revenue and earnings growth.
And in fact, the oldest of soft drinks companies, Coca Cola, is rocking a relatively expensive PE ratio of 30 (the S&P average is around 15), at a massive market cap of $200b and revenues of $32b. Their operating margin hovers around 20-25%.
So Fever-Tree are achieving superior margins to the world’s biggest oldest soft drinks company at a much smaller size, and without an insanely higher PE ratio.
Fever-Tree’s revenues are less than 1% of Coca Cola’s. So there’s still a lot of market left to go after. If you view Fever-Tree as a beverage company, you might decide it deserves the same valuation as any equivalent food and drinks.
However, if you see it as almost akin to a growth startup in its field and a potential major brand of the future, that punchy valuation may matter much less to you.
Let us know what you think of Fever-Tree as an investment (and a mixer) and whether it’s found its way into your portfolio!
Personal disclaimer: I own 6 shares of Fever-Tree stock. This is not a personal recommendation to buy or sell, nor is it financial advice. Everyone should do their own research and make their own investment decisions based on their circumstances, goals and risk tolerance.
Freetrade does not provide investment advice and individual investors should make their own decisions or seek independent advice. The value of investments can go up as well as down and you may receive back less than your original investment. Tax laws are subject to change and may vary in how they apply depending on the circumstances.
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