Why I’d sell Fevertree Drinks plc to buy this stock

Investors who took shares in the 2014 flotation of Fevertree Drinks (LSE: FEVR) have seen the value of their stock rise by 1,023% in less than three years. I suspect this company has created a number of new millionaires among UK investors.

The secret to the stock’s rocketing growth is that sales and profits have repeatedly beaten forecasts. This is still happening. Tuesday’s interim results revealed that sales have risen by 77% to £71.9m during the first half of the year. Adjusted earnings per share doubled to 16.7p, up from 8.1p for the first half of 2016.

The board now expects full-year results to be “materially ahead of its expectations”. The shares have risen by 9% to a new high of almost 1,900p. So why would I sell some of this stock today?

The numbers tell a story

This is clearly a great business, with an attractive product, high profit margins and a strong balance sheet. Today’s results make it clear that the group still has significant growth potential by expanding overseas, and moving into the market for dark spirits mixers, like cola.

However, it’s worth noting that Fevertree has accounted for 99% of the value growth in the entire UK mixer retail market over the last 12 months. It now holds a 30% market share. Without stealing huge slices of business from incumbents such as Coca-Cola and Schweppes, I find it hard to see how much higher these figures can rise.

After today’s news, I estimate that the stock trades on a 2017 forecast P/E of about 55. The risk for investors is that profits could double again and the shares would still look expensive. Founder Charles Rolls recently sold a quarter of his shares, netting £73m. I’d consider doing the same.

This is what I’d do with the cash

I don’t think the market for soft drinks and mixers is going to disappear in my lifetime. Government plans for a sugar tax have been effectively handled by drinks firms, who don’t seem to expect any impact on sales.

If you’re keen on this sector, what I’d do would be to recycle some cash from Fever-Tree into another high quality company that’s more mature, and offers a decent income. My choice would be A.G. Barr (LSE: BAG), which owns brands including Irn Bru, Rockstar, Snapple and Strathmore. The company also produces drinks for other companies.

These brands trade at a lower point in the market than Fever-Tree’s premium mixers. But Barr’s business has a very long pedigree. Robert Barr started selling soft drinks in 1875. The group recently held its 113th annual general meeting.

Although the shares aren’t cheap on a forecast P/E of 20, they offer a yield of 2.5% that’s covered twice by earnings. Dividend growth has averaged 9.1% per year since 2012. The group’s operating margin has averaged an impressive 15% over the same period.

Investors in Barr won’t double their money next year. But this is a stock I’d buy on the dips, and would be happy to hold through a recession. In my view, buying Barr would be a good way to convert some Fever-Tree profits into a long-term income.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended AG Barr. 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.