2 UK stocks with recovering profit margins

This writer considers a pair of UK stocks with very different share price trajectories following the pandemic. Would he buy either?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Businessman use electronic pen writing rising colorful graph from 2023 to 2024 year of business planning and stock investment growth concept.

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The pandemic had a devastating effect on many companies. Some UK stocks dropped 50% or more as their profit margins were hit badly.

Thankfully, many shares have since recovered, with some at or near all-time highs. Others have yet to fully bounce back and remain well down.

Here, I’ll look at two UK stocks with recovering profit margins, but markedly different share price performances in the aftermath of Covid.

Passive income stocks: our picks

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

A huge winner

The biggest turnaround stock in recent times has been Rolls-Royce (LSE: RR). Four years ago, as global travel was still at a standstill, the Rolls share price was 107p. Now it’s 410% higher at 546p!

Created with Highcharts 11.4.3Rolls-Royce Plc PriceZoom1M3M6MYTD1Y5Y10YALL28 Nov 201928 Nov 2024Zoom ▾Jan '20Jan '22Jan '24Sep '20May '21Sep '22May '23Sep '24Jan '20Jan '20Jan '23Jan '23Jul '21Jul '21Jul '24Jul '240200400600www.fool.co.uk

The turnaround at the company has been stunning, as CEO Tufan Erginbilgiç reminded us back in August.

Our transformation of Rolls-Royce into a high-performing, competitive, resilient, and growing business is proceeding with pace and intensity…We are on track to deliver our mid-term targets.

Rolls-Royce CEO Tufan Erginbilgiç, H1 2024 earnings report

Since taking over in January 2023, he’s implemented a comprehensive transformation strategy to enhance the company’s profit margins. This has included renegotiating contracts, selling off non-core businesses, and implementing cost-cutting measures.

These actions have led to a significant improvement in operating profit, which rose to £1.6bn in 2023. The underlying operating margin was 10.3%, up from 5.1% in 2022.

And the progress continued in H1 this year, with the underlying operating margin improving to 14%. By 2027 (that is, medium term), it could reach 15%.

Source: Rolls-Royce H1 2024

The issue here, of course, is that the market is fully up to date with this progress. And after the engine maker’s mighty rise skywards, the stock’s trading on a forward price-to-earnings (P/E) ratio of about 26.

There’s risk in that premium valuation if, for example, supply chain issues hamper growth or another pandemic suddenly sweeps across the world.

Nevertheless, I’ll be hanging on to my shares that I first bought at a much lower price. But I’m wary to buy any more at 546p.

A huge loser

One stock that certainly hasn’t bounced back yet is Fevertree Drinks (LSE: FEVR). This is the company that makes posh mixers like elderflower tonic water to enhance the taste of spirits.

The share price has crashed 70% in four years and now languishes near an eight-year low.

Created with Highcharts 11.4.3Fevertree Drinks Plc PriceZoom1M3M6MYTD1Y5Y10YALL28 Nov 201928 Nov 2024Zoom ▾Jan '20Jul '20Jan '21Jul '21Jan '22Jul '22Jan '23Jul '23Jan '24Jul '242020202020212021202220222023202320242024www.fool.co.uk

The firm has experienced significant cost increases, particularly surging glass costs driven by rising energy prices. This has resulted in huge gross margin pressure on the business.

Consider this contrast between H1 2016 and H1 2024.

H1 2016H1 2024
Revenue£40.6m£172.9m
Gross margin54.8%35.9%
EBITDA margin30.7%10.5%

While revenue has grown significantly, the gross margin has decreased from 54.8% to 35.9%. And the EBITDA margin has contracted significantly. In other words, Fevertree’s profitability has suffered badly.

However, the gross margin in H1 improved 520 basis points from the year before. This was due to improved glass pricing, reduced transatlantic freight expenses, and optimisation efforts. Management expects further ongoing improvement in profitability.

With a forward P/E ratio of 20.3, the stock’s a bit pricey for me, especially as consumer spending may remain weak for some time.

Still, Fevertree’s ongoing margin recovery isn’t being appreciated by the market at present. So I think the stock, which now carries a 2.5% dividend yield, has the potential to bounce back strongly over time.

Is this a top choice for growing wealth now?

Before deciding, we think this pick is another must-see.

Discover ‘One Top Growth Stock from The Motley Fool’ absolutely FREE.

Though past performance does not guarantee future results, over the past 5 years, it’s seen consistent double-digit revenue growth. ‘Return on capital’ - a key measure of business quality - is a colossal 57%. That’s almost 6 times higher than the UK average!

Best of all, it has a cult-like following. Customers who’re raving fans, potentially spending more money, more often - whatever the economy.

In our experience, discoveries like this are extremely rare.

So please, don’t leave without seeing, ‘One Top Growth Stock from The Motley Fool’, which includes both the Risks and opportunities.

Claim your FREE copy now

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Ben McPoland has positions in Rolls-Royce Plc. The Motley Fool UK has recommended Fevertree Drinks Plc and Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

artificial intelligence investing algorithms
Investing Articles

Up 272% in just a year, is Palantir stock just getting started?

This writer recognises that Palantir has grown its business very well -- but does the stock price offer him an…

Read more »

Runner standing at the starting point with 2025 year for starting in new year 2025 to achieve business planing and success concept.
Investing Articles

Up 50%? The Aston Martin share price forecast is mind-blowing! 

If analysts are right, the Aston Aston Martin share price could absolutely rocket in the year ahead. Harvey Jones says…

Read more »

Investing Articles

As the S&P 500 drops, here are 2 Stocks and Shares ISA holdings I’m watching

Our writer has different views on how President Trump's tariffs might affect these two US holdings in his Stocks and…

Read more »

Surprised Black girl holding teddy bear toy on Christmas
Investing Articles

£10,000 invested in Tesla stock at Christmas is now worth…

Tesla stock has been one of best-performing investments of the past decade. But things haven't gone to plan for investors…

Read more »

Investing Articles

Up 279% in 5 years, could Meta stock keep soaring?

Meta stock has more than tripled in five years. This writer sees lots to like about the business but also…

Read more »

Pink 3D image of the numbers '2025' growing in size
Investing Articles

25% total return in a year? Is now the perfect time to buy BP shares?

BP shares are on the front line of today's global economic and political uncertainty but analysts think they can still…

Read more »

Affectionate Asian senior mother and daughter using smartphone together at home, smiling joyfully
Investing Articles

With Cash ISA changes coming, could now be the time to consider buying shares?

Changes to the Cash ISA could lead to greater investment in the stock market. This could be a good thing…

Read more »

Investing Articles

These FTSE 100 dividend shares just got cheaper, thanks to President Trump!

Investors buying dividend shares can lock in bigger long-term yields when share prices take a tumble. These two just did…

Read more »