Britvic (BVIC)


Stockwatch: A value play with 23% upside

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Stockwatch: A value play with 23% upside

Has a near two-year fall in mid-cap soft drinks company Britvic (BVIC) finally established an inflection point, as now underlined by a bullish, reverse head-and-shoulders pattern?

In some respects Britvic's trend has typified the market: on the back of quantitative easing (QE) the shares roared to test 780p a share in 2012/13, before traders cashed in awaiting earnings proof.

In fairness, the table shows respectable single-digit earnings growth for a £1 billion-plus company, notwithstanding a slip to 2% growth in the current financial year.

The "head" of a head-and-shoulders pattern is defined by a drop to 525p after the 30 November prelims affirmed "challenging" prospects. But the dividend yield is kicking in - even after a recovery to 585p the prospective yield is 4.5% twice covered by forecast earnings.

There have been concerns over higher input costs and government action against sugary drinks, but reading the detail of Britvic's statements, management is already creating efficiencies and capitalising on public demand for low/no sugar drinks.

New Year interest

The stock is also rising after another Brazilian acquisition, with several brokers re-iterating 'buy' and targeting 680p to 725p - which implies a forward price/earnings (PE) ratio of 13 and sub-4% yield as a more appropriate rating. The group derived 64% of revenues from the UK in 2015/16, but should benefit to some extent from its exposure to France (17%) and Ireland (9%), assuming the euro doesn't fall further in a potential crisis year.

Britvic is 'the cheapest stock' on 11.5 times its 2017/18 earnings' estimates

Brazil, the world's sixth largest soft drinks market, represented 6% of group revenue as a result of the £114 million acquisition of Ebba in July 2015 - a leading supplier of concentrates and nectar drinks, popular in Sao Paulo and the North East. After this subsidiary achieved 19% revenue growth in the last year, Britvic has extended its interests with the £54.5 million acquisition of Bela Ischia Alimentos, market leaders in Rio de Janeiro.

Britvic claims "substantial annual cost synergies" for combining the operations, and Morgan Stanley looks for low single-digit earnings enhancement in the first full year. This also derives from debt-funding (an existing facility) which is manageable despite Britvic's weak net cash flow while capital spending remains high: see the trend in capex versus cash flow in the table, which leapt last year.

Morgan Stanley reckons Britvic is "the cheapest stock in our coverage universe" on 11.5 times its estimate of 2017/18 earnings per share (EPS). I would add that's interesting from a US investment bank, also considering the post-referendum drop in sterling, as it makes Britvic attractive especially for US acquirers.

Rising cost inflation

Exacerbating the early December plunge to 525p was a change in stance by Goldman Sachs from "conviction buy" to "neutral". The broker was concerned about rising input cost inflation in the UK, although management reckons it can mitigate this through cost savings and "revenue management activities" - it would help if this was clarified better.

Last year a transformational three-year investment programme (hence the rise in capex) was declared to deliver better supply chain flexibility/efficiency, quantified as a minimum 15% improvement at the operating profit level from a net £240 million net investment.

So Goldman's concern was possibly overdone, although it could have just been an excuse to tidy up its "conviction buy" list at the end of the year, the stock having under-performed since Goldman's added Britvic two years ago. The medium-term prospect for costs remains quite a guess, given the uncertainty for input inflation, but if said efficiency improvements are achieved then they should contain it.

Soft drinks, anyone?

Last year's results showed a circa 10% rise in profits on revenue up 10.1% to £1,431.3 million, albeit like-for-like revenue up only 0.4%.

There was some variance with carbonated drinks up 5.3% like-for-like in the UK whereas still drinks were "challenged" - Robinsons declined after added sugar was removed from the range and there was "very competitive" own-label pricing by supermarkets. "J20 had a weak Christmas (2015) and our limited-edition flavours performed poorly this year", however J20 Spritz, a low-sugar sparkling variant, performed well.

The number of under-25's abstaining has leapt 40% in eight years to more than a quarter

While a mixed reflection on the brands, this may reflect a general shift to carbonated drinks as no/low sugar versions of Pepsi Max, 7UP and Tango (Britvic is a PepsiCo distributor) all did well in the UK.

7UP Free outperformed its category with double-digit growth last year and Tango delivered its best performance in over a decade. Clearly, such legacy brands can flourish if they adapt. 2017 will include new offerings such as the re-launch and extension of R Whites Lemonade, new adult premium brands and premium mixers.

A positive long-term factor is that teetotalism flourishing - the number of under-25's abstaining has leapt 40% in eight years to more than a quarter of this segment. Despite an alcohol crisis among affluent older people, one in five of the UK population don't drink and it's one in three for London - presenting a big marketing opportunity for non-alcoholic drinks.

Another angle is sports drinks amid the machismo for triathlon, endurance cycling and the like, which Britvic could acquire into. So the war on sugar could end up net positive, boosting demand for new refreshments.

Buy territory

Admittedly, Britvic isn't expected to deliver the financial proof of its fine words on brand and efficiency improvements until 2018. But there's a parallel in the way the chart is bottoming out and how the company is fighting forward in the sugar war and to cut costs; in which context Goldman's downgrade is a classic capitulation.

This company ought to exemplify how Britain can flourish outside the EU single market, already exporting to some 50 countries globally with franchise partnerships in the US, Australia and India.

It should benefit from fresh trade agreements and lower sterling, and shareholders from rising overseas revenues in growth markets such as Brazil. On that basis its equity is now in 'buy' territory as the chart affirms.

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Britvic - financial summary Consensus estimates
year ended 02 October
2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 1256 1322 1344 1300 1431    
IFRS3 pre-tax profit (£m) 77.5 82.6 120 138 152    
Normalised pre-tax profit (£m) 85.1 120 136 148 164 159 172
Operating margin (%) 9.2 11.1 11.9 13.1 12.9    
IFRS3 earnings/share (p) 22.4 25.3 36.2 41.2 43.5    
Normalised earnings/share (p) 24.5 39.1 42.7 45.3 48.3 49.2 53.4
Earnings per share growth (%) -20.3 59.5 9.3 6 6.6 2 8.4
Price/earnings multiple (x)         12.1 11.9 11
Annual average historic P/E (x) 12.4 18 17.7 16.4 14.4    
Cash flow/share (p) 42.9 47.4 49.8 58.4 42.9    
Capex/share (p) 19.5 14.4 23.3 22.9 44    
Dividend per share (p) 17.9 17.8 6.1 21.5 23.3 25 26.7
Yield (%)         4 4.3 4.6
Covered by earnings (x) 1.5 2.3 2.3 2.2 2.1 2 2
Net tangible assets per share (p) -111 -113 -87.8 -35.7 -52.1    
Source: Company REFS

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.