Shares in soft drinks producer A.G. Barr (LSE: BAG) are 2% weaker today after the company released a somewhat disappointing update. Although profitability for the full year was rather impressive, with profit on ordinary activities increasing by 10% versus the prior year, a lower level of inflation and the potential for a period of deflation are making life difficult for the manufacturer of Irn Bru and Rubicon.
In fact, Barr reported that the soft drinks market saw price deflation towards the end of 2014 which, if it continues, will clearly make top and bottom line growth highly challenging for the business. However, there is optimism for investors in the company, with its energy drinks and water products seeing growth increase at an impressive rate. In fact, water is now its biggest category, while its Rockstar energy drink saw sales rise by over 4% in 2014.
The problem for Barr, though, is that its current valuation appears to price in a relatively successful medium-term outlook for the business, which may not materialise. Certainly, its bottom line is still forecast to grow by at least as much as the wider index over the next two years, with growth of 6% in the current year being expected for example. However, with its shares having risen by 11% since the turn of the year, they now trade on a price to earnings (P/E) ratio of 21.2, which appears to be rather excessive. As such, its share price could realistically come under pressure in the near term – especially if soft drinks prices further their decline.
Although Barr has now ventured into the alcoholic drinks market via the purchase of the cocktail mixers business, Funkin, it still appears to be overly reliant on the soft drinks market. Certainly, the alcoholic drinks business is also highly competitive, but offers more robust pricing opportunities and more stable demand than soft drinks. As such, sector peers such as Diageo (LSE: DGE) (NYSE: DEO.US) and SABMiller (LSE: SAB) appear to be worth a premium to Barr – especially when they offer greater regional diversity (being far less reliant on the UK for sales) and also have a wider range of products, including multiple premium alcoholic drinks brands.
However, SABMiller’s premium to Barr is only small, with it having a P/E ratio of 22.4 (versus 21.2 for Barr), while Diageo’s premium compared to Barr is only negligible, with it having a P/E ratio of 21.4. As such, SABMiller and Diageo appear to offer better value than Barr – especially when you consider that they are forecast to increase their bottom lines by 8% and 9% respectively next year.
As a result, and while Barr could prove to be a sound long term investment, Diageo and SABMiller seem to offer better value and a more robust future top and bottom line performance. As such, they appear to be better buys.