Scottish soft drinks group AG Barr (LSE: BAG) has enjoyed a strong start to the year and I believe its shares seem well placed to deliver capital growth and healthy dividend income going forward.
Market share gains
The fizzy drinks maker, whose brands include Irn-Bru, Rubicon, Strathmore and Funkin, is seeing steady market share gains and impressive sales momentum on the back of recent new product launches. Revenue in the six months to 29 July was up 8.8% to £126.6m, beating the 2.6% total sales growth in the wider drinks market.
On the downside though, the company’s market-beating sales growth came at a cost of its margins. Higher costs associated with increased marketing investment, product innovation and weaker sterling caused its operating margin before exceptional items to fall by 70 basis points to 13.2%. As a result, underlying profits in first half increased by just 2.9% to £17.5m.
However, as the underlying fundamentals remain positive, the impact to profits is only going to be temporary. Moreover, AG Barr’s increased spending is mostly down to its sugar reduction and reformulation programme, which positions the company in a strong place ahead of the implementation of the UK sugar tax in April next year.
On the dividend front, I believe AG Barr has plenty of scope to increase cash payouts to shareholders. Free cash flow has been holding up well, as capital expenditure has started to taper after big investments in the past few years. The balance sheet is also in good shape, with the company in a net cash position of £7.9m.
Year to date, the shares have climbed 23%, while the FTSE 250 Index is up just 8% over the same period. Despite this, valuations seem reasonable for a company with a strong track record of innovation. AG Barr has a forward price-to-earnings (P/E) ratio of 19.8 and a dividend yield of 2.3%.
Meanwhile, shares in roadside assistance company AA (LSE: AA) fell by as much as 10% today after the company cut its forecast for full-year profitability. It now expects full-year earnings before interest, tax, depreciation and amortisation (EBITDA) would be between £390m and £395m, down from £403m last year.
The AA said it had been facing “increased costs related to erratic workload patterns and the relatively inflexible resourcing model,” which has held back its profitability. Moreover, delays to its IT transformation programme are set to cost the company an additional capital expenditure of £35m.
This is not good news for investors who are already concerned about the indebtedness of the company. With net debt of £2.7bn and a leverage ratio of 6.7x, the company does not have much room for manoeuvre. As profits decline, the company may struggle to support its high dividend yield as it needs to invest more to sort out its inefficient cost structure and fix its IT issues.
Although shares in the company are temptingly priced, at just 7.6 times expected earnings next year, I reckon the AA is a risky turnaround play.