You’d think that investors would have learnt to be pessimistic when it comes to Fever-Tree’s earnings. Chasing market share has come at a price of heavy costs and margins that have shrunk over the past five years. And the prospect of any relief to all that has been hit by rapidly rising inflation.
Higher transatlantic freight costs and raw materials prices mean that stronger sales won’t feed through to better earnings. The drinks group has guided towards earnings before interest, tax and other charges of between £69 million and £72 million for this year, below an analyst consensus forecast of £75 million. A margin that had been expected to return to growth is now set to be flat on last year at about 20 per cent.
The maker of posh tonics has capitalised on the revival of gin in Britain and fancier tastes among drinkers willing to spend more on mixers. Rapid revenue growth had made the Aim-listed group a stock market darling, spurring a rise in the shares of more than 2,000 per cent between 2014 and a 2018 peak. But concerns over a slowdown in sales growth within a maturing UK market and the hefty costs associated with international expansion have hamstrung the shares since then.
Pandemic impact aside, some of the challenges to margins have been one-offs, such as cash spent on cutting prices in the United States in 2020. But investment in adding customers — including hiring staff, marketing and taking on new premises — is a recurring drain on funds. Analysts at Liberum, who downgraded the stock from a “buy” to a “hold” on the back of yesterday’s trading update, cut their adjusted earnings forecasts for this year and next by 10 per cent, to £71.9 million and £89.7 million, respectively. The company reckons the margin will return to growth next year, which Liberum interprets as an adjusted pre-tax margin of 21.6 per cent. Bringing distribution closer to international markets should provide some relief against freight costs. A bottling facility on the east coast of America is due to step up production in the coming months; another is due to open in Australia next year.
The premium tonic specialist argues that gaining market share is the main prize and it is willing to sacrifice margins to attain that, for now. Admittedly, revenue growth has been impressive, up almost a quarter last year and ahead of the level suggested in September. Revenue guidance for this year has been upgraded, too, encouraged by a recovery in higher-margin on-trade sales as pubs and bars reopen and expectation that at-home demand will stick above the pre-pandemic level.
Heady sales expectations are built into the group’s enterprise value, which sits at almost eight times forecast sales for next year. That’s even after some froth coming out of the shares, which are down just over 40 per cent from their peak. But given the continued margin pressure, a share price that represents 51 times forward earnings, above an historic multiple of 45, is problematic.
Efforts to maintain strong revenue growth could continue to have two negative side-effects. First, it means the drinks specialist will need to keep investing in staff, marketing and general product development as it seeks to broaden its range of mixers beyond its staple tonic and to expand further in America. Second, it limits the ability to push through price increases that would be substantial enough to ease pressure on margins, particularly given uncertainty over how long materials inflation and higher freight costs persist. You can understand that reluctance, to some extent, but it also means the shares are at risk of further punishment.
Advice Avoid
Why The current valuation leaves little room for error, which could materialise if inflation persists for longer than anticipated
NCC
Two Achilles heels emerged for NCC, the cybersecurity specialist, at the end of last year: one, a toppy forward price-earnings ratio that peaked at 38, characteristic of the sector but an attribute that left it vulnerable as the market shifted away from growth stocks; and, two, being a people-based business in an already skill-short industry, which has left it exposed to wage inflation.
Yet the adjusted operating margin held steady during the first half of the year as higher costs were passed on via increases in consultant day rates. That was even after the core assurance business had increased staff headcount by 12 per cent.
The group has two main divisions: assurance, which provides cybersecurity consultancy services; and a higher-margin software resilience business. The latter acts as a digital vault, storing code for clients that would enable them to rebuild software lost in a cyberattack.
More cash was spent on addressing historic underinvestment in the latter business, including expanding the sales team and automating marketing. The consequences of being tight-fisted linger, something that Adam Palser, the chief executive, calls “a self-inflicted wound”. Revenue in the first half was down 3.3 per cent on an underlying basis.
The $220 million acquisition of IPM last year was another part of reviving the business. It has boosted the group’s presence in the American market and should provide NCC with the chance to sell assurance services to IP’s new customers. But growing corporate spending on cybersecurity globally means the assurance business is pegged as the source of higher growth — an annual double-digit rate against single-digit growth expected from software resilience.
Tighter corporate budgets as the Omicron variant emerged meant a slower start to the new financial year for the assurance division. Management said there had been an acceleration in orders for both businesses from December. Analysts forecast adjusted earnings of 11.79p a share, up from 9.5p last year.
Since the end of August, NCC’s shares have fallen just over 50 per cent and trade at a more reasonable forward earnings multiple of 18.
Advice Hold
Why Prospect of further recovery in orders
