The Motley Fool

Why I’d buy pricey Fevertree Drinks plc ahead of this cheap growth stock

On the face of it, Wizz Air (LSE: WIZZ) looks like an unbeatable bargain with its shares trading at only 16 times forward earnings as the Central European budget airline grows sales and profits by double-digits. But even though the company’s interim report released this morning showed great results and increased full-year profit guidance, I’d still ditch it in favour of highly valued Fevertree Drinks (LSE: FEVR), which trades at a whopping 56 times forward earnings.

Storm clouds on the horizon? 

My bearish outlook on Wizz Air doesn’t come down to short-term issues or internal problems, as the 25% year-on-year jump in revenue and profits posted in the six months to September shows the company’s growth is still robust.

Rather, I see problems coming for the entire industry as budget carriers ramp up capacity growth at the same time as demand growth for such services begins to slow. In this fiscal year Wizz Air expects to grow capacity by 23% while larger competitors such as Ryanair and easyJet are looking at around 10% capacity growth each.

This risks becoming an untenable situation over the medium and long term as there is little chance passenger demand will keep up with this level of growth. Just ask, well, nearly every air carrier in history how this story ends when supply rises outstrip demand increases and fares plummet to keep sales high enough to cover leasing and other fixed costs.

That isn’t to say this problem is just around the corner though, as load factors across the industry are currently enviably high and Wizz Air’s geographical focus on an under-served region should lend it a great runway for growth. However, with economic expansion, the core driver of air travel demand, across Europe being tepid at best, I won’t be buying shares of any budget carrier right now.

Consolidating pole position 

Despite its astronomical valuation, I’m much more likely to take a chance on Fevertree Drinks (LSE: FEVR). For one, the company is far and away the leader in the upscale mixer market and is beginning to transform into the leader for mixers in general in the UK. Over the past year it’s been responsible for a full 97% of sector growth by value for soft drinks as a whole. This is a position not even the company forecast when it went public and means its potential sales growth is much higher than many analysts have predicted.

And I see little reason this growth potential can’t be matched overseas. For the six months to June, growth accelerated year-on-year in every region the group trades in, with European sales up 64%, US sales up 43% and the rest of the world up 45%. Now, there will be kinks to work out in each of these markets but the company’s founder-led management team instils me with confidence that the issues will be dealt with.

There’s no doubt Fevertree is expensive, but its valuation should look a little saner once analysts upgrade their forecasts after this week’s trading update showed sales and profits materially ahead of market expectations (its fifth such upgrade in the past year). With huge growth potential the world over and, thus far, little competition from entrenched incumbents, I still fancy Fevertree for the long term, despite its lofty share price.

If you prefer your growth stocks to have valuations that are more down to Earth, I recommend reading the Motley Fool’s free report on its Top Growth Share of 2017. This founder-led company’s shares have risen over 170% in value over the past five years yet they still trade at under 22 times forward earnings.

The Fool’s Head of Investing believes the stock could triple in the coming decade, and to discover his reasoning, simply follow this link to read your free copy of his report.

Ian Pierce has no position in any of the 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.