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Why I’d dump a 10-bagger for this small-cap growth stock

While investors should never dwell on their regrets, one that must top many lists is failing to buy shares in tonic water specialist Fevertree Drinks (LSE: FEVR) towards the end of 2014. If you’d had the skill (or good fortune) to do this, the value of your holding would have increased tenfold over the last two-and-a-half years.

Can the shares continue to rise? Sure, assuming the company can provide evidence that it has managed to build on last year’s excellent performance when it delivers half-year figures on 24 July. 

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The only problem with this is the fact that 2016 was such a superb year for Fevertree. April’s full-year report highlighted a 73% increase in revenue (to £102m) and 97% rise in adjusted EBITDA (to almost £36m). Beating these figures in 2017 is no easy task and any sign that momentum is slowing could see many holders jettison the stock from their portfolios.

To further muddy the investment case, Fevertree’s popularity as a growth stock par excellence following its tendency to beat earnings estimates has left it trading on a gravity-defying 61 times forward earnings.

And given that anything over, say, two is indicative of a stock trading at a fairly high price relative to the predicted growth of the underlying company, Fevertree’s price-to earnings growth (PEG) ratio of over 5.2 also implies that the stock looks horribly expensive.

A more appealing option

If, like me, you’re put off by the possibility of Fevertree’s crown slipping, an alternative stock with decent growth credentials might be drinks wholesaler, distributor, and retailer, Conviviality (LSE: CVR). Today’s full-year results were certainly encouraging.

Thanks to a series of acquisitions (which all appear to have been integrated ahead of schedule), the £550m cap business grew revenue by 85% to £1.56bn in the year to the end of April, with adjusted pre-tax profits rocketing 111% to just under £46m.  

Broken down, the company reflected that all areas of the business had performed strongly.

A 6.4% increase in revenue (to just over £1bn) was seen at Conviviality Direct (its wholesale unit) with a total of 235 customers being added over the course of the year. 

Trading under its Wine Rack and Bargain Booze brands, revenue at its retail arm rose 6.1% to £378m. A total of 39 new franchisees joined the company last year, bringing the total number to 352 (and over 700 stores). 

In Conviviality Trading — which serves festivals and outdoor events — sales hit £146m — a rise of 1%.

Given this more-than-adequate performance, you might expect the shares to be trading at a fairly high valuation. This simply isn’t the case. Right now, you can pick up its shares at just 13 times forecast earnings. 

Remember Fevertree’s sky high PEG? Conviviality’s is 1.8 for 2017. That means investors will be getting access to earnings growth an awful lot more cheaply at the latter.

In addition to its reasonable valuation and growth potential, it’s also worth highlighting that the Crewe-based company’s shares come with a forecast 4.3% yield for the new financial year, nicely covered by profits. Given that levels of free cashflow at Conviviality climbed 349% to £51m by the end of the last financial year (which permitted the company to raise the full-year dividend by no less than 33%), I wouldn’t be surprised if the stock also becomes a core holding for many income investors in the years ahead.

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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