Inflation made this success story go flat – but the future looks promising
Consumer-focused stocks have endured a torrid time over recent years. Rampant inflation and fast-paced interest rate rises have combined to put household budgets under significant pressure. This has encouraged consumers to cut back on discretionary items and trade down to cheaper own-brand products.
It is therefore unsurprising that shares in beverages company Fever-Tree have slumped since being added to our Aim portfolio in October 2023. They have fallen by 19pc, versus a 1pc decline for the FTSE Aim All-Share index, as tough trading conditions have weighed on the company's financial performance.
Indeed, the firm's recently released annual results showed that sales rose by just 3pc year on year. However, lower materials costs and falling freight rates meant that the company's gross profit margin rose by 540 basis points to 37.5pc. This caused the firm's earnings per share to increase by a far more impressive 82pc versus the prior year.
Further profit growth, however, is not anticipated in the current year. In fact, Fever-Tree is forecast to post a low single digit increase in revenue and a 6pc decline in earnings this year as its dominant US division, which accounts for 35pc of sales, transitions to a long-term strategic partnership with Molson Coors.
Outside America, the company expects to deliver further profit margin growth this year as it benefits from a strong competitive position. Indeed, during 2024, the firm gained market share across all of its key regions. This suggests it is becoming increasingly well placed to capitalise on an improving consumer outlook.
Although inflation remains above target in the US, Europe and the UK, which together account for 91pc of the company's sales, it is widely expected to fall to central bank targets over the medium term. This should provide scope for further interest rate cuts that, alongside modest price rises, prompt improved spending power among consumers.
In turn, this is likely to have a positive impact on demand for premium discretionary products such as those sold by Fever-Tree.
An increasingly upbeat industry outlook is reflected in the company's financial forecasts for next year. It is expected to post a 19pc rise in earnings per share in 2026, with investors already beginning to factor in a rapidly growing bottom line. The company's shares have risen by 16pc since the start of the year and now trade on a price-to-earnings (P/E) ratio of 27.8.
While this is clearly expensive, especially relative to many UK-listed smaller companies, it does not represent an overvaluation in Questor's view. The prospect of further rapid profit growth amid a buoyant long-term consumer outlook means the stock is worthy of a premium valuation vis-à-vis the wider stock market.
Furthermore, Fever-Tree has solid fundamentals that help to justify its lofty market valuation. For example, its net cash position increased from around £45m to nearly £84m last year.
This suggests it has the financial means to overcome further consumer-related challenges in the short run. In addition, a return on equity figure of 10pc, achieved despite the use of very modest leverage, highlights its competitive advantage and status as a high-quality business that enjoys significant brand loyalty.
Separately, the firm is making progress in diversifying its product portfolio. Indeed, 45pc of the company's sales are now derived from products other than tonic water. This is five percentage points greater than in the previous year and equates to a more reliable long-term financial outlook as consumer tastes inevitably change.
In the short run, the company's share price performance could be boosted by a £100m buyback programme. However, its market valuation is likely to remain relatively volatile as above-target inflation and a restrictive monetary policy take time to pass.
And with the company viewing 2025 as a transitional year as its partnership with Molson Coors is implemented, Questor would be unsurprised if recent share price growth fails to be replicated over the coming months.
Still, Fever-Tree's long-term prospects remain sound. Its growing market share means it is well placed to take advantage of an improving industry outlook as consumer demand for premium discretionary products increases. And, while its P/E ratio is undoubtedly high, the company's solid fundamentals and upbeat earnings growth outlook mean it remains a worthwhile purchase.
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