Tuesday 25 July 2017

FEVER TREE; 'the tonic that makes a gin and tonic'

Fever Tree (FEVR:LON)

Disclosure: this post was written around Feb 2017 but wasn't published as I had not received consent from my new employer.

Fever Tree is the ‘tonic that makes a gin and tonic’. The company was set up by a former distiller who realised the best gin with a poor tonic is a poor gin and tonic, hence he set out to make the best tonic water.

Business model

FEVR has an ultra asset-light model as they outsource all bottling, packaging and distribution to third parties. They have around 30 staff for production and sales and marketing. The model is hugely scalable. FEVR partners with distributors in globally to market and sell the product.

Normally, the brand and the distributor will share the marketing expense. So FEVR will put up around 5% of the total value of product given which would then be matched by distributor. This 10% is then spent on marketing and shifting the goods. The gives FEVR huge scalability with minimal capital required. The adjusted ROIC (subtracting out intangibles) was 43% and 49% for 2014 and 2015 respectively. A FEVR distributor also recently commented, ‘one thing I love about these guys is nothing is ever sold on promotion. Ever’. Although it is still early days and you wouldn’t expect discounts or promotions for such a premium band, it’s reassuring management are putting the brand first.

The brand has grown 100% in 2016 in the UK, its largest market. The company is nowhere near at scale in US and has only dipped its foot into Asia and China.

There is also no assumption on cross-selling into darker soft drinks.

Total addressable market

The global tonic market is set to grow to 1150 K MT by 2021. With roughly 1150 litres in a metric tonne this equates to around 1.15m litres of tonic globally addressable for Fever Tree.

Fever Tree sold around 47-50m litres in 2016, giving them around 4-5% market share globally today. The average price per litre sold is £2.1 and on 2015 operating margin of 30% this gives £0.64 operating profit per bottle. Also, once this brand begins to scale globally, pricing power can potentially improve margins further.

If FEVR grow litres sold by 30% for the next 4 years to reach 100 litres sold worldwide. At an operating profit per litre of 0.78 this equates to £100m operating profit in 2020.

With a company with c 45-50% ROIC - this would equate to a 25-30x nopat multiple which gives an EV of £2740. This gives 14% 4 year annual return of a tried and tested premium brand. Also, although investing in a company wishing it to be purchased by a strategic is not clever there are not many premium brands that would fit into any of the majors' portfolios like FEVR. However, he price a strategic would pay and thus the valuation floor in this scenario is a different conversation.

Valuation

What do long run economics look like?

COGS - purchased inventory which makes up raw materials, bottling, distribution and outsourcing manufacturing. It’s all outsourced. This will enable FEVR to benefit from localised bottlers and manufacturers and scale to different regions maintaining very similar unit economics as we see today. Possibly slightly lower GM for larger regions due to higher distribution costs.  

Admin expenses are labour costs and overheads which do not scale as business grows.

Assumptions: Where can I be wrong?

FEVR is obviously a huge valuation. £1.6bn is 16x revenue. But are there any reasons US consumers won’t buy into FEVR?

Litre growth is key here. Units sold.

I am assuming:

  • The long run economics look similar to today’s number due to scalability of the business model.
  • The quality and premium nature of the brand will enable it to grow worldwide. Premiumisation is a global trend and consumer tastes towards premium tonics are not vastly different regionally.
  • I am not assuming any growth in new products.
  • Litres sold will treble in 5 years. Litre growth has slowed slightly to 63% YOY last year. Is a growth rate for the next 5 years of 30% too high? We will see.





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