The soft drinks maker is a good business, but the shares are too pricey, says Phil Oakley.
Britvic is Britain’s biggest soft drinks company, selling more than two billion litres of still and fizzy soft drinks a year. The company can trace its roots back to the mid-19th century, when a Chelmsford chemist started making home-made soft drinks.
Before it changed its name to Britvic in 1971, the business traded as the British Vitamin Products Company, which used drinks as a way for people to get their vitamins.
Today the company owns some of the best-known soft drinks brands in the country, such as Robinsons, Tango, J2O and Fruit Shoot. It also has licences to make and bottle Pepsi and 7UP in the UK and Ireland. In recent years the company has expanded overseas.
It has bought businesses in Ireland and France, which have experienced mixed fortunes. It has also started selling its Fruit Shoot drinks in America and India.
Spurned advances
Back in 2012, Britvic’s profits took a hammering from having to recall faulty batches of Fruit Shoot. Shortly afterwards it was approached by its Scottish rival, AG Barr, with the aim of creating one of Europe’s biggest soft drinks businesses. This would probably have been a good deal, but Britvic decided to go it alone with a new strategy.
Since then the company’s profits and share price have been trending sharply higher. Yet the business still faces many challenges. Can the good times keep rolling – or could Britvic shares be about to lose their fizz?
Britvic’s decision to knock back AG Barr’s advances looks to have been the right one – for now. The company has recently reported a very decent profit performance for the year to September and currently has a market value of £1.7bn – the same as Barr and Britvic combined were valued at two years ago. All is well – or so it would seem.
However, dig a little further into the company’s financial performance and there’s definitely cause for concern. Yes, an 18.8% rise in annual earnings per share (EPS) and a 13.6% hike in the dividend is welcome – but it’s how those numbers were achieved that could be the problem on the horizon.
Sales are the lifeblood of any successful business. Without getting more money into the company’s coffers from selling more products, it’s difficult to keep on growing profits. Britvic’s sales only grew by 1.7% last year. During the second half, sales actually fell by 1.3%.
Sales of Pepsi Max and Fruit Shoot are growing reasonably well, but people are buying less Robinsons Squash and J2O. The market for still soft drinks in the UK has shrunk slightly, with water the only category showing meaningful growth. Unfortunately for Britvic, it doesn’t have a big water brand to capitalise on this trend.
Elsewhere, sales in France were held back by the disruption caused from bringing a new production line into service. In Ireland, cash-strapped consumers are keeping their hands in their pockets and looking for value for money. This has pushed selling prices down. In other markets, Britvic has raised prices to offset the damage from selling fewer drinks.
Slashing costs
So how has it grown its profits? Mainly by slashing costs – it’s shut down two factories and a depot in the UK. And cost cutting should help profits grow again in 2015, albeit at a lower rate than this year.
But what happens to profits when the cost cutting runs out? There’s no way around it – Britvic needs to get its sales growing again. But this is not going to be easy. Consumers are increasingly avoiding sugar-loaded soft drinks and opting for healthier choices, such as water.
In any case, the lack of wage growth in the UK means there’s no guarantee the soft-drink market is capable of growing particularly strongly. There is also the growing threat of supermarket own-label products for items such as squashes. The dire state of Britain’s supermarket chains and the resulting price wars between them is also likely to drive down selling prices.
So where is the sales growth going to come from? Well, Britvic is being more active in pushing its low-calorie drinks, which could attract more health-conscious consumers. Fruit Shoot also has a lot of potential.
The brand is growing rapidly in France, while Britvic has also signed a 15-year franchise agreement with PepsiCo to sell it in America. It has also teamed up with a local partner in India.
If sales growth is hard to come by, then it’s difficult to see profits growing over the medium term. This might bring AG Barr or another merger partner to the negotiating table and a deal could be done. But with Britvic’s valuation a lot richer than it was a couple of years ago, I’m not sure that the financial logic for a merger deal is as compelling as it was a couple of years ago.
Should you buy the shares?
Britvic is a very good business. Its return on capital employed (ROCE) is a mightily impressive 29%. It generates a decent amount of cash flow, enabling it to pay a rising dividend. But like most views on what to do with a share, it boils down to price.
Britvic shares don’t look horrendously expensive – but they are not cheap either. The danger is that if in a year’s time sales aren’t growing, then profits growth may be heading for a brick wall. On that basis, existing shareholders might want to think about selling while the going is still good.
Verdict: take some profits
Britvic (LSE: BVIC)
Share price: 691p
Market cap: £1.7bn
Net assets (Sept 2014): £83.1m
Net debt (Sept 2014): £426m
P/e (prospective): 14.9 times
Dividend yield (prospective): 3.3%
EBIT/EV (latest): 7.4%
Interest cover: 6.2 times
Dividend cover: 2.0 times
ROCE: 29%
What the analysts say
Buy: 11
Hold: 8
Sell: 3
Target price: 798p
Directors’ shareholdings
S Litherland (CEO): 32,616
J Gibney (CFO): 244,687
G Corbett (Chair): 53,695