Why I’d sell plc to buy Fevertree Drinks plc

Fevertree Drinks (LSE: FEVR) and Boohoo.Com  (LSE: BOO) are probably the highest profile growth stocks trading in London today. 

It’s easy to see why investors like these companies, even though they are both relatively young businesses. Since the beginning of 2016 shares in Boohoo and Fevertree have climbed by 531% and 290% respectively as earnings growth has accelerated.

Of the two, I believe Fevertree has more potential for future growth because the company has a stronger brand and enormous international market to crack. While Boohoo has been able to drive growth by disrupting the online clothing market, the nature of the company’s business is not that much different from peers like Asos. What’s more, the online clothing market is extremely competitive, profit margins are small, and it’s relatively easy to start a competing business.

On the other hand, Fevertree’s drinks are bespoke. While copycat companies are springing up, Fevertree’s already established reputation and scale gives it a competitive advantage that has many similarities to that of Warren Buffett’s favourite investment Coca-Cola

Higher returns

If you compare the two businesses side-by-side, Fevertree’s advantages become apparent. 

For example, for fiscal 2017, Boohoo reported an operating profit margin of 10.3% and return on capital employed — a key measure of how much profit the company is eking out of every £1 of investment — of 26 4%.

These metrics are highly impressive (most companies fail to generate a return on capital employed more than 10%) but they look relatively weak when compared to those of Fevertree. Specifically, for fiscal 2016 the company reported an operating profit margin of 33.6% and return on capital employed of 35.3%. 

Similar valuations 

When you’re comparing two high-growth stocks that both have comparatively similar valuations and growth rates, profit margins and efficiency can be a deciding factor. 

On a valuation basis, the two companies are somewhat indistinguishable. Fevertree trades at a forward P/E of 64.2 falling to 57.2 for 2018. Analysts are projecting earnings per share growth of 16% and 12% for 2017 and 2018 respectively. 

On the other hand, Boohoo’s earnings are expected to grow faster, but the company’s shares are more expensive. At the time of writing, shares in the company trade at a forward P/E of 76.5 for the fiscal year ending 28 February 2018, falling to 61.2 for the following fiscal year. Earnings per share growth of 33% and 24% are projected.  

Granted, over the next two years Boohoo’s earnings are expected to grow faster but as mentioned above, unlike Fevertree, for the long term it’s questionable whether or not the company can continue this rate of growth as competitors try and take away market share.

The bottom line

So overall, if I had to choose between Boohoo and Fevertree, the latter would win my money as it has a brighter long-term outlook. 

Even though Fevertree has a lower projected growth rate, with an established brand, the group should be able to continue to grow at a steady rate for longer as it enters new markets.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended 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.