Stockwatch: A great play on changes in UK drinking habits

This company has scope to become a premium global brand in its sector and further upgrades are possible, believes companies analyst Edmond Jackson.

Is this one of the better defensive stocks? Britvic (LSE:BVIC) is the UK's largest supplier of branded still soft drinks and second placed for carbonated drinks, its year to end-September 2018 showing mid-single-digit revenue/profit growth and, according to recent consensus, a price/earnings (PE) ratio reducing from the mid-teens sub 12 times, against a 3.3% prospective yield.

Over 2018, the stock blipped in a 670-856p range, ending the year where it started at around 800p, which demonstrates resilience of a sort. This month the share price has risen over 7%, establishing a new high of 858p, driven largely by a pattern of broker upgrades. Last December, analysts at Berenberg raised their target from 900p to 950p and UBS raised theirs last Friday from 870p to 920p.

While annual results for the year ended 30 September 2018, published at the end of November, were unexciting, management guided for a "material increase in free cash flow as capital spend falls back towards normal levels". Their narrative is likely also helping upgrades, Britvic being seen as near the end of a "business capability programme" with around half the £11 million profit benefits realised, hence a strong platform for 2019 to better drive growth. 

Source: TradingView, weekly chart (*)  Past performance is not a guide to future performance

Quality defensive stocks should be kept in focus

While the real action this January has been among cyclicals sold heavily late last year, rebounding to "in line" 2018 trading updates, quality defensive stocks should remain a priority.

Soon we shall see what fourth-quarter figures and outlooks beckon for US companies - generally over-leveraged – and the confusion that is Brexit is liable to weigh on the UK economy. 

In the unlikely event Mrs May's deal passes parliament, a legal log-jam means Britain will anyway not leave the EU on 29 March, increasingly likely is a long messy disruptive path to a second referendum – or even worse for equity investors, a general election where a discredited/in-fighting Tory party gets replaced by a radical left-wing government, prompting capital flight. Bargains would ensue but only after a nightmare for buy-and-hold investors.

Long-term benefits of positioning in low/no sugar drinks

I initially drew attention to Britvic two years ago when the shares were trading at around 575p, suggesting the stock was at an inflection point, both operationally and in terms of market sentiment.

A reverse head-and-shoulders chart pattern had followed the 2016 results, and investment banks such as Goldman Sachs had capitulated into downgrades after like-for-like annual revenue rose only 0.4% despite headline revenue/profit up over 10%.

Despite some difficulty discerning what portion of drinks revenues are strictly low/no sugar (Britvic reports in terms of a "GB stills/carbs" revenue breakdown; then Ireland, France, Brazil and rest-of-international) I thought that products modernisation bodes well.

A public health information war on sugar continues - erupting again this New Year - and alcohol consumption declines.  Despite a drinking crisis among affluent older people, a fifth of the British population drinks no alcohol, likewise a third of Londoners, and abstinence among the under-25's has soared 40% in eight years to over a quarter.

Frequently, the chief non-alcoholic offering in pubs is the likes of J2O, a Britvic brand, and there looks plenty further scope for innovation.  For domestic consumption, Robinsons has seen the introduction of new premium squashes that improved market share despite fears the supermarket own-brands could take over. With health scares over levels of British obesity and tooth decay among children, the context looks opportune for low/no sugar soft drinks marketing despite a challenged economy.

Source: Company REFS   Past performance is not a guide to future performance

An overseas marketing opportunity too

I concede, however, that the numbers haven't really backed my hopes for Britvic as a potential Brexit play. Given it exports to some 50 countries globally, it should benefit from freshly enhanced trade agreements and lower sterling. 

Brexit stasis thwarts that, while sterling is also a double-edged sword – strengthening on perception that 'no deal', if not Brexit itself, is being kicked into the long grass by parliament.  Yet sterling is liable to weaken again if Brexit stalemate persists, in a sense the uncertainties will exact a toll on the economy. 

Britvic's competitive evidence has been mixed, however, notwithstanding a recent shortage of CO2 in Western Europe.  Last year, the French soft drinks market declined amid poor weather, although Britvic's Fruit Shoot brand lost share as competition intensified; thus French revenues slipped 5.7% at constant exchange rates or 4.3% when mitigated by sterling weakness.  Ireland did better, up 8.3% at constant exchange rates or 12.5% actual, led by squash brands and mineral water.

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The acquisition of Bela Ischia in Brazil became fully integrated and its synergies were ahead of guidance to roll out products such as Fruit Shoot (which has also raised its profile in the US). Yet macro headwinds meant that after revenue slipped in the first half it was only possible to end 2018 up 0.8% at constant exchange rates; but FX was not supportive, hence actual revenue eased 2.8%.

This can put into question Britvic's string of acquisitions since 2015, although Brazil remains the world's largest concentrates market, so there is strategic rational to build there.  International revenue, which include the US currently in an "investment phase", saw better progress - up 4.9% at constant exchange rates or 5.8% actual – despite declines in Asia and the Middle East taking the shine off Benelux.  Mind this segment constitutes only 3.3% of group total revenue.

Altogether, it positions Britvic well to expand abroad but more proof of overall progress is needed. The UK represented 59.3% of last year's revenue, up from 57.6% in the 2017 year, making the stock substantially a play on changes in UK drinking habits – a move away from alcohol and lower sugar intake.

Cash flow growth prioritised for debt reduction

Negative net tangible assets (as of last September-end) follow from £439 million intangibles, representing 116% of £377 million net assets, though it seems fair to ascribe intrinsic value to a portfolio of respected brands. 

Rising debt is more the issue, particularly near-term up 91% to £171 million, while longer-term it has edged up 3% to £598 million.  It is mitigated by cash, up 33% to £109 million for net debt of £560 million, which generated a £20.3 million net interest charge covered 8.2 times by operating profit.

That's hardly stretched, but less than what you'd want to see objectively, certainly if interest rates are turning a corner and to avoid the "balance sheet" weighing on perception.  Management would likely point to circa £137 million spent on property, plant and equipment in each of the last two years, plus £113 million spent on acquisitions (including intangibles) as justifying this hike in debt, when barely £18 million was received from disposals in the last two years.  

The financing side of the cash flow statement refers also to drawdown and partial repayment of private placement notes, but reiterates debt.  So, I would expect to see this being addressed with the anticipated increase in cash flow as investment reduces than any re-rating of dividends.

Mixed aspects to the rationale, but it implies 'Add'

All-considered I continue to like the prioritisation of low/no sugar drinks which also supplant alcohol. Britvic's rating appears fair, but upgrades are relatively recent, so may represent the early stage of a trend now that an investment programme is broadly completed.

Brazil and France beg questions over a 'defensive' tag if revenues there have been materially affected by the local economic context. But this is not a company exposed to US/China trade tensions unless consumer spending is undermined. Volatility could resume, but I think Britvic has scope to become a premium global brand in its sector, even a bid target, so remains one to watch and accumulate long-term.  Add.

*Horizontal lines on charts represent levels of previous technical support and resistance. Trendlines are marked in red.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.