Interactive Investor

Stockwatch: time to upgrade this £2bn UK company to ‘buy’

24th May 2022 12:05

by Edmond Jackson from interactive investor

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Most of us will have its popular products in our kitchens, and companies analyst Edmond Jackson likes the growth and income characteristics of this business.  

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When companies declare the start of a share buyback programme, to what extent is it an admission that growth prospects are lacking? Would not higher dividends be a more genuine “return” to shareholders, like I just recently argued the case for at Capricorn Energy (LSE:CNE)

It exemplifies the “agency dilemma” arising where directors are meant to act on behalf of shareholders, but remuneration schemes tend to use earnings per share as a benchmark for executive pay, hence possibly a bias towards buybacks. 

Britvic (LSE:BVIC), a £2.2 billion mid-cap soft drinks group, is a latest example where you also might wonder that if growth prospects are so good then why not return earnings to prioritise investment? While its return on capital has trended in mid-teen percentages, net gearing around 140% means return on equity is recently estimated at around 30%. 

Yesterday, it declared the start of a £75 million buy-back programme, potentially to last up to end-February 2023. It sounds attractive, how a maximum 26.7 million shares would represent a 10% cut in share capital, meaning a material enhancement to earnings per share (EPS) numbers – although with the market price up nearly 4% yesterday to 843p the cost of all those shares would be £225 million. 

Britvic’s market price anyway does look interesting in a long-term chart context, especially if recessionary fears are overdone such that low-ticket consumer spending items such as branded soft drinks enjoy more demand as Covid continues to ease in the UK. 

De-rating to a long-term upwards trend-line 

Britvic fell from exactly 1,000p last August, extending the drop from around 900p to 740p last March when Russia invaded Ukraine. This marks reversion to a steady uptrend from around 200p post the 2008 financial crisis.  

I originally drew attention as a “buy” in June 2017 at 575p, suggesting an inflection point operationally – with scope for Britvic to become a premium global brand in low/no sugar drinks amid a trend to supplant both alcohol and sugar. 

Then, in November 2019, and applying a “hold” rating at 990p, I was concerned how Britvic shares appeared to fall between two stools – of looking pricey for growth investors on a price/earnings (PE) ratio of over 16x for its modest growth rate, while a yield just over 3% was immaterial as a prop should events worsen. On current forecasts, the 12-month forward yield is still only 3.6%, hence confidence in the business is required. 

The financial summary table shows a drop in profitability from the September 2019 year, explained initially by investment – and then Covid compromised people buying drinks when out socialising. Fair enough and recent interims to March were strong. 

The brands include Fruit Shoot, Robinsons, R Whites, 7UP, Tango and J20, plus a distribution licence for various PepsiCo products.  

Time will tell what autumn/winter brings, yet Covid infections do appear to be in continued decline – significantly due to the UK’s successful vaccination programme.

The UK remains most significant for Britvic, constituting 69% of first-half-year revenues versus 22% for “other international”, Ireland, and 9% for Brazil. It is the UK’s largest supplier of branded still soft drinks and the second-largest in carbonated. 

Recessionary fears may be overdone, supporting demand for low-ticket consumer items 

Although management contends that demand for branded soft drinks has been relatively stable during past downturns, a legitimate recent concern might have been how supermarkets – especially the likes of Aldi and Lidl – might poach revenue as pressured consumers resort to “value” alternatives. 

But yesterday, Pantheon Economics argued in a note that UK consumer spending is holding up despite high inflation and low confidence. People could be using savings or debt to keep spending, and a strong labour market might be mitigating unemployment fears. A recession should be averted with only minor slippage in this current quarter of 2022 before modest growth resumes.  

If that is a fair scenario, then people used to buying the likes of Robinsons rather than supermarket drinks should continue to do so.   

All products contributed to strong first half results 

Six-month results to 31 March reflected strong dynamics: after-tax profit up 49% to £46 million on revenue up 19% to £719 million, with EPS and the interim dividend up around 20%. Sales and price growth were enjoyed across all business units, hence so far so good in terms of passing on cost increases. 

Possibly a reason the shares did not much respond was the CEO’s narrative referencing “significant” levels of inflation as likely to persist amid geo-political uncertainty, and weigh on consumer spending “at least into 2023”. 

UK growth did however accelerate nearly 22% like-for-like over January to March, led by products typically bought out-of-home as socialising increased. Home products have seen revenues rise 13% over two years and are now ahead of pre-Covid levels. 

Investment continues in UK core brands and future growth such as Plenish, organic plant-fuelled drinks and milks. 

The group also owns a spread of local brands in Ireland, France and Brazil – a major new market for soft drinks – and is exploring other territories through franchising, export and licensing. 

Brazilian revenue grew around 15% like-for-like at constant exchange rate in the six months to March, having already achieved market shares in the high-teens’ percent. Significant cost inflation has persisted however, hence price increases have been implemented and vertical integration pursued – i.e. towards raw materials production. Brazil is obviously a mass consumer market if initial success can extend. 

Ireland saw 23% growth and France 12% despite a challenging trading environment; and price rises in France only partially mitigated higher costs. 

Management says revenue momentum continued in April; but if growth prospects are looking up then why not prioritise investment over buy-backs?  

At the end of March there was also only £24 million cash relative to £580 million debt and £75 million lease liabilities, which generated £8 million net finance costs taking 12% of interim operating profit.  

You might also reasonably wonder if debt reduction would make better sense than buybacks as interest rates edge up. 

It explains why I am sceptical of buy-backs despite upgrading my rating of Britvic equity. 

Near 12% operating margins are pretty good if possibly capping the extent of PE multiple the market is prepared to apply; unless, say, Brazil takes off as a growth story. 

Unexciting interim free cash flow of just £2 million was unchanged on the 2021 first-half-year, with £95 million generated from operations offset by working capital movements. Inflation contributed to higher inventories to protect customer service levels, and capital expenditure increased slightly to £25 million. 

So, while the interim results highlights appeared to flag “growth”, more substance is required. Presumably the board views buybacks as one means to assure higher EPS. 

Britvic - financial summary
Year-end 30 Sep

Turnover (£ million)1,4311,4311,5041,5451,4121,405
Operating margin (%)
Operating profit (£m)173158166130130161
Net profit (£m)11511211780.994.6103
EPS - reported (p)43.542.244.130.335.438.6
EPS - normalised (p)50.361.966.163.754.042.9
Operating cashflow/share (p)50.574.977.969.463.286.9
Capital expenditure/share (p)46.355.554.128.018.727.6
Free cashflow/share (p)4.119.423.841.344.559.3
Dividends per share (p)24.526.528.230.021.624.2
Covered by earnings (x)
Return on total capital (%)20.215.915.612.711.613.7
Cash (£m)20682.511049.010971.1
Net debt (£m)576590660635635583
Net assets (£m)281339377415376411
Net assets per share (p)107129143156141154

Source: historic company REFS and company accounts. Past performance is not a guide to future performance.

Growth moderation, yet takeover prospects also 

Consensus looks for an impressive 29% EPS growth to 55p this year, then slow to 8% and 60p for September 2023. This would still be below numbers achieved pre-Covid, hence Britvic may chiefly be undergoing an upwards mean-reversion of performance as the pandemic eases. 

A radical option would be for a predator to rip out central costs and integrate the brands. I would say this is an interesting possibility than probability. 

Yesterday’s strong price rebound appears to show Britvic having reached a firm support level, hence was sensitive to an upturn in market sentiment. I upgrade Britvic shares to “buy”, with a return to previous highs around 1,000p plus dividends, potentially offering a 20% return. 

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


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