Why Fevertree shares could rally by a quarter to one-year high

Despite a recovery in recent months, shares in this AIM giant are still a fraction of where they were five years ago. But one City expert has just upgraded their view to buy.

A longer-lasting recovery for shares in Fevertree Drinks (LSE:FEVR) has been forecast after a City bank this week upped its target price by 24%.

HSBC believes there’s scope for a profits surprise as cost headwinds begin to normalise and the upmarket tonics firm continues to harness opportunities outside the UK.

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In a note published on Monday, the bank switched its recommendation from “hold” to “buy” and moved its price target from 1,290p to 1,600p.

Such a level would represent the highest for AIM-listed Fevertree in over a year, having fallen as far as 804.5p in the autumn due to significant pressure on margins.

The strain has included soaring glass costs, as well as labour shortages on America’s east coast that forced the company to ship supplies from the UK at a time of high freight rates.

The shares have recovered by more than a fifth since March, although worries over how high interest rates might impact consumer confidence at the start of the summer season mean they’ve drifted away from the 1,456p seen at the time of May’s in-line trading update.

HSBC believes sales trends are still positive as it looks for momentum in the US, Italy, France and Australia, where the brand is driving the premium mixer segment from the bottom up.

Overall revenues in 2022 increased by 10.7% to £344.3 million, split between 34% in the UK, 29% in Europe and 28% in the United States and 9% in the rest of the world.

In the UK, Fevetree has broadened its portfolio with drinks specifically designed for the soft drink occasion and through new non-carbonated cocktail mixers in four classic variants.

In addition, sales in bars and restaurants have defied concerns on the consumer spending outlook by showing an acceleration in like for like rates in the most recent trading update.

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Analysts at the City bank add that the cost outlook is improving, having seen the company’s margins contract materially over the past two years.

They forecast a further decline in half-year results, but believe the majority of additional costs suffered in 2021/22 should unwind rapidly by the second half of 2023.

European energy prices are back level with 2021 and HSBC believes there’s reason to think the £20 million in extra glass costs budgeted at the start of the year may prove too pessimistic.

On the back of this improved cost outlook, the bank has moved back to valuing the group using its historical five-year earnings multiple of 31.2 times.

The bank said: “With confidence rebuilding around the US opportunity, we see scope for profits to recover ahead of expectation as the market gathers scale more quickly and energy and commodity prices normalise.”

At one point in 2018 Fevertree traded on 70 times forecast earnings for a market value of £4 billion, a level that made it the toast of those retail investors who bought shares on the way up.

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This momentum reflected the benefits of a largely outsourced business model, which gave Fevertree the flexibility to pursue opportunities in new markets including America.

However, the model has left it more exposed to the significant cost headwinds, while the impact of a potential consumer spending downturn also clouds the outlook.

It was last year’s highest dividend payer on AIM, with £68.8 million distributed in 2022.