Stockwatch: Stay the course at this winner

After shares of soft drinks group Britvic have rebounded to a two-year high around 825p, should you take profits, or might the arrival of a sugar tax actually be a blessing for sales of low/no-sugar drinks?

Early in February, with the price down 9% from 790p to 720p after a mushy Q1 update, I suggested "buy on weakness" as concerns intensified over the tax hurting sales from 6 April 2018.

The stock fell as low as 668p but, in a classic example of fears over-doing a drop, it has rebounded sharply since the tax came into effect and, following robust interims for the 28 weeks to 15 April, it now tests 830p where several brokers assert 'buy'.

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Some say the results are well ahead of expectations, but mind Britvic still has plenty to achieve before its October year-end relative to the consensus forecast (see table) as of 4 May. This appears anyway to have reduced by 10% from £177 million albeit increased by 3% for 2019.

The analysts' consensus hasn't always been right. When I first drew attention at 585p in January 2017 it was trending negatively due to the sugar tax, despite annual results showing post-tax profit up 10%. The summer boom period for soft drinks should at least support another strong H2 if difficult to be precise.

Source: interactive investor           Past performance is not a guide to future performance

Good underlying progress despite a mixed profile

Adjusted interim pre-tax profit is up 12.2% to £49.8 million on revenue up 4.8% to £733 million, although on a headline basis pre-tax profit is down 13.7% to £33.3 million due to investment costs plus closing a Norwich factory, and organic revenue is just 2.8% ahead.

The numbers derive from being one of Europe's leading branded soft drinks businesses, the largest supplier of branded still soft drinks in the UK (second in carbonated) and the leader overall in Ireland. Last financial year's revenue split was 62% UK, 19% France, 9% Ireland and 9% Brazil after a 2015 acquisition made it the leading supplier of concentrated dilutable drinks and the no.2 supplier of ready juices.

Adjusted earnings per share (EPS) rise 12.2% to 21.2p versus full-year 2018 expectations of about 30% growth in the normalised figure (albeit for a 13 month year) near 55p based on a 16% advance in normalised pre-tax profit to £138 million.

So, there's certainly more to do in H2 where management is suitably vague about "continuing to make progress in the rest of this financial year". It has raised the interim dividend 9.7% to 7.9p per share, though this is small relative to the 27.3p full-year projection.

It cites a positive price/sales mix delivering balanced revenue growth, contending Britvic enters the soft drinks levy environment with "strong momentum", the Robinsons brand resuming growth and Pepsi Max outperforming a highly competitive cola market. Manifestly organic sales need to show better progress but, in fairness, it's been a very long winter and this scorching May bodes well for soft drinks as summer kicks in.

Capital investment is said to be in a final phase with cost/commercial benefits now being seen, which ought to improve the cash flow profile. As yet, the interim cash flow statement shows operational cash flow down from £44.6 million to £26.2 million although 2017 enjoyed a much greater H2 contribution from the summer months - such that full year operational cash flow was £198 million. H1 2018 saw £99.4 million spent on investment and acquisitions, thus with dividends costing £50.8 million and working capital issues, the cash flow statement shows cash nearly halved to £44.2 million.

Quasi growth rating: 15% operating profit advance?

At 825p, the forward price/earnings (PE) multiple is in the mid-teens and prospective yield approaches 3.5%, i.e. the company needs to prove better growth otherwise in time the market could de-rate its stock again to exact a more meaningful yield.

Mind, the UK soft drinks market as measured by Nielsen analysts showed only 2% growth in 2017, although Britvic achieved revenue growth of 4.6% in its H1 2018. France weakened slightly, said due to poor weather hurting syrup sales, although Ireland enjoyed 6% growth with low/no sugar brands as drivers.

Such sales' variances provide a tricky aspect for overall forecasting, alongside management's claim its investment programme should deliver a minimum 15% advance in operating profit from 2020. Another uncertainty is how supermarket own-brands may evolve as cheaper alternatives to those affected by the sugar tax although. In cola, British taste buds firmly favour Pepsi supermarket offerings and indeed Coca-Cola, which bodes well for no-sugar Pepsi MAX.

Near £700 million net debt: a positive benefit to value?

Britvic's extent of debt looks manageable in terms of being long-term-oriented (private placement notes maturing 2019 to 2032) if exposed increasingly to what rises in short-term interest rates the Bank of England decides on.

Within flat net debt of £692 million, April 2017-18, the interims reveal a 133% leap in short-term debt to £280 million, while long-term debt has eased 25% to £456 million and the net interest charge clipped 21.0% of operating profit. This increase in short-term debt, if combined with rate rises, could therefore weigh more heavily on the income statement.

Management justifies the debt by way of financing investment, e.g. the table showing annual capital expenditure doubled since 2015 and being substantial relative to cash flow. They have been trying to impress shareholders both with investment and dividend growth, a feature of very low interest rates in recent years where previously dividends would be cut or omitted. Time will tell how prudent this is.

The trend in UK inflation figures implies a 2017 jump was a transient feature of sterling's devaluation after the June 2016 EU referendum, thus, if a scenario of broadly low rates persists, then Britvic's debt policy may yet prove optimal for shareholder returns.

Net gearing still remains high at 218%, also with respect to intangibles comprising 136% of net assets (hence persistently negative figures for net tangible assets per share). Yet a branded products group like this is going to have significant intangible value that a trade buyer would recognise.

Britvic has a £400 million bank facility, 44% drawn down, alongside £503 million private placement notes, so at least the lenders are satisfied even with debt increasing (say for an acquisition).

Stay the course for now

So, the figures involve contrasts, there's no margin of safety beyond brand appeal, and the stock is not exactly growth or income criteria. Yet a major investment phase is maturing, with benefits ahead, and the sugar tax fears could be a red herring – Britvic poised instead to capitalise on the trend to low/no sugar, also away from alcohol.

Time will tell, but the narrative is promising, and better sentiment is established. A Q3 trading statement is due 24 July. Hold.

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