Fevertree Half Year Update

Fevertree, the UK’s premium tonic maker, issued a half year trading update earlier this week on the 20th to show how the business has performed, as many of Fevertree’s markets have started to re-open. As I explained in my February note on Fevertree, the story behind the investment case is now that of international expansion. In this article, I will provide a check-in on Fevertree at the half year point by looking at its recent results, its international markets and by updating financial estimates for the business.


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Recent Results


Fevertree's financial highlights from their half year report released on the 20th July 2021
Source: Fevertree's Half Year Report

Fevertree’s most recent update provided results for the half year to 30th June. On a revenue growth basis, Fevertree’s results were very impressive. Total like-for-like growth of 34% for the period versus the prior year led to Fevertree increasing its full year revenue guidance range to £295m - £304m from the prior expectation of £282m - £292m. This expectation for 2021 would now mean Fevertree expects growth of 17% - 21% for the full year. Such buoyant trading has been underpinned by a very resilient performance in the UK; given that the ‘on-trade’ (restaurants and bars) haven’t been at full capacity for the six month period, people have still been stocking up on premium mixers in ‘off-trade’ locations (supermarkets and shops). US results were also very strong at 42% growth in constant currency, but the real stand out performer was Europe, with 81% like-for-like growth in constant currencies and 104% with the inclusion of the recent GDP acquisition, a German drinks distributor. Strong European performance is due to the re-opening of ‘on-trade’ venues, typically a higher portion of sales in this market compared to the UK. Large amounts of re-stocking took place in the period, as on-trade venues prepared for a strong level of summer trading.


‘As the On-Trade has reopened we have continued to see good momentum in the Off-Trade driven by increased adoption of long mixed drinking at home and increased support from retailer and spirit partners. Consequently, we continue to strengthen our market share across our regions.’ Fevertree Half Year Report

The quote above also highlights how Fevertree is being rewarded for its re-invention of itself as a brand that can be enjoyed both at home or whilst out in pubs and bars.


Gross Margin Dilution


Whilst Fevertree’s results were stellar from a revenue growth perspective, there was some disappointment in terms of Fevertree’s profit margins. Fevertree’s gross margins have continued to slip over the last few years as shown by the decline from 50.5% in 2019, to 46.2% in 2020. They are now expected to slip further to 45% in 2021.


For the half year update, margin pressure was explained by the business as due to the twin headwinds of covid-related logistics troubles and increasing logistics costs and the general price inflation of raw materials, which in turn have diluted gross margins.


There was no mention in the update that Fevertree is looking to raise prices. Therefore, it looks as though the business will be absorbing these cost increases in pursuit of growth as opposed to passing on costs to the customer base.


The business expects some of this pressure to abate in the coming months and for margins to improve into 2022. However, it is likely that some input costs will remain elevated as suppliers lock in new prices.


International Progress


The UK market has been a fantastic test bed for Fevertree since the founding of the business in 2005. A high population density of gin guzzling Brits provided the perfect environment for a premium tonic business. However, there is a limit to which the business can continue to grow in this fairly small geography and the goal for Fevertree in the medium term has been to expand into larger markets such as the US and Canada.


The primary opportunity for Fevertree on the global stage is the US market. Whilst the US is by no means the biggest consumer of alcohol by units, as many European and Asian nations trump the US on per capita alcohol consumption, the US’s large population and love of premium brands means that it comprises one of the largest markets in terms of total expenditure for alcohol. With a total value of over $160 billion for alcohol expenditure, it is easy to see why this is a potentially lucrative market for Fevertree. Consumption in America is pretty fairly weighted to a balance of off-trade and on-trade sales as shown by the graph below, somewhat similar to the UK where Fevertree has perfected its model.


A table showing the total alcohol expenditure in the US since 1935 adjust for inflations and including taxes and tips from 1989 to 2014. The source of the image is USDA ERS. The table shows that the largest alcohol expenditure is from restaurants and bars and the second biggest alcohol expenditure is from liquor stores.
Source: USDA ERS

Spirits as a share of total alcohol consumption in the US has also been growing, as consumer preference shifts away from beer and wine towards spirits based ‘long mixed drinks’. As of 2020, spirits now account for 39.1% of US alcohol sales, up from 34% in 2014. The premium and super premium categories of spirits have been out-pacing growth in other sectors for the spirits trade, especially in 2020 as lockdowns boosted sales of premium tequila and cognac for at home consumption.


The large market for spirits and a focus on quality premium brands in the US makes for fertile ground for Fevertree, with its often touted explanation that there is little point mixing a $50 premium spirit with a cheap, low quality mixer loaded with corn syrup.


However, there are innate challenges in bringing the UK’s tonic success story to the US. Firstly, the US market for spirits is dominated by bourbon and tequila. Gin sales make-up roughly $1 billion in the US versus over £2 billion worth of sales in the UK. Seeing as Fevertree’s tonic is primarily suited to gin, unless the company can crack other product lines such as mixers for the tequila or bourbon market, it may prove difficult to replicate British success in the US.


There are tentative signs Fevertree is rising to this challenge, having signed the largest US spirits distributor Southern Glazers to distribute its products and recently in 2020 succeeding in setting up a US bottling line.


An image showing the grocery webpage of Target's website showing the price and reviews of Fevertree's Sparkling pink Grapefruit tonic water.
Source: Online Grocery at Target.com

Product related success has been evident too. In its 2020 full year report, Fevertree noted that the launch of its Sparkling Pink Grapefruit tonic, targeted at the tequila market, had been been highly successful. Looking at some online US grocery research, to which I will delve into more later, the Pink Tonic seems to have gone down a treat, with Target (one of America’s largest grocery stores) offering it online to 5 star reviews.


A photo of Qmixers Spectacular Tonic Water in both a can and in a bottle.
Source: Qmixers.com

A second challenge for Fevertree in the US is competition. When Fevertree entered the UK market with its premium line of tonics there was little direct competition other than poor quality, low priced mixers from companies such as Schweppes. In the US, Fevertree looks to have a well-established competitor Qmixers with its Q spectacular tonic range. Qmixers looks to have started in a similar fashion to Fevertree with the below quote from its entrepreneur founder.


'It was probably the gin, but the idea was stuck in my head. Justin brought this great (and expensive) bottle of Tanqueray over, and we were mixing drink after drink with something that wasn’t any good. Right then, I looked up. The moon was shining down on the table. The light caught the Tanqueray and it looked like a glowing orb of green gin goodness. Next to it, the plastic tonic water bottle, with its label peeling off and its contents going flat, looked particularly decrepit. In a flash, I realized I should make a better tonic water – one made from real ingredients and good enough to mix with my favorite gins.'


Despite Fevertree engaging in various product launches in the US, a scan of the online grocery channel (Target, Kroger, Walmart) shows that Qmixers products are typically a dollar cheaper per pack and are running better promotions than Fevertree. Whilst it's important to note this is only the online channel and Fevertree could be better positioned in-store, it is clear there is an established competitor in the premium tonic segment.



A screenshot of a grocery search on Walmart's website for tonic water, which shows that Qmixer's Spectacular Tonic Water has 320 4.5 star reviews and costs less than Fevertree's tonic waters.
Source: Walmart.com, a grocery search for 'Tonic Water'

Despite these challenges, Fevertree still managed growth in the US of 23% for the full year 2020 and 42% (constant currency) in the first half of 2021. Whilst being the only player in a category has clear advantages, I would go as far to say that having a small to medium sized competitor such as Qmixers could be a good thing for Fevertree, for the reason being that Fevertree needs to sell the Americans on its ‘premiumisation’ story: the idea that mixing premium branded spirits with premium mixers makes sense. This story becomes much easier with the addition of other brands communicating the same message. In turn, it could lead to faster category expansion as premium mixers take share from the likes of Schweppes, Canada Dry and own brand labels.


Financial Estimates


A financial table that shows the Revenue, Growth, Gross Profit, Gross Margin, EBITDA, EBITDA margin, EPS, P/E and Net Cash for Fevertree in the year 2020, with estimates of these figures for the years 2021 and 2022 from The Twenties Trader.
Source: Fevertree Results and Twenties Trader Estimates for 2021 and 2022

Utilising Fevertree’s commentary around 2021 outlook and margin expectations, I have compiled the above table to estimate Fevertree’s financials for 2021 and 2022. As you can see, 2021 comprises a banner year for Fevertree as re-stocking leads to strong growth in the 20% region. However, despite record revenues, Fevertree won’t surpass its pre-pandemic level of profitability and earnings per share due to margin contraction. Thus the P/E multiple remains stubbornly high at 58 times earnings for 2021. It is not until 2022, where further but more moderated growth combined with improved profit margins as logistics cost pressures unwind, where there is a result in a return to the pre pandemic earnings levels of 50p+. It is here in 2022 where I would expect the Fevertree investment case to accelerate if we see signs of continuing the high growth trajectory seen in 2021 or margin improvement. Despite the pandemic and low growth rates in 2020, Fevertree remains to hold a net cash position, giving it the flexibility for strategic acquisitions and the potential payment of special dividends to shareholders in 2022.


Summary and Evaluation


Checking in on Fevertree at the half year point, the trajectory for growth has improved in the short term, but margins offer a source of disappointment. In Fevertree’s favour, logistics cost pressures are likely to settle down in H2 and reduce further in 2022 as the world manages to resolve the current logistical complications such as shipping container scarcity. It is likely that margin improvement will be seen in 2022, and if growth in core markets continues it is likely to be a positive catalyst for the share price.


Fevertree remains a very high quality business, with industry leading return on invested capital due to its asset light strategy. Looking at US retail penetration Fevertree remains in the very early stages of its international expansion, and I would expect it has yet to fully convince new markets of the premiumisation story in spirits mixers.


To me the business model still makes a lot of sense, given the overall trends shifting away from low quality alcohol to premium brands. I see Fevertree as an attractive proposition over the long term despite trading at an estimate of 46x 2022 earnings.


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At the time of writing, The Twenties Trader did own shares in Fevertree.


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