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5 reasons why I’d buy the Fevertree Drinks share price (and 5 reasons I’d steer clear!)

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Shares in flavoured tonic water supplier Fevertree Drinks (LSE: FEVR) tanked last week after it revealed revenue and profits would come in lower than previously expected following a weak end to trading in 2019. Like many investors, I’ve been weighing up the reasons for and against building a stake in the former market darling. Here’s my take.

Reasons to be optimistic

The first reason Fevertree’s shares might be worth buying is simply based on the assumption that the market has overreacted. Despite flagging sales in the UK, growth overseas (including 33% in the US) has been encouraging. You might argue that Fevertree is merely experiencing the predictable pains endured by all successful businesses when their domestic markets mature.

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Second, Fevertree has a history of scoring highly on metrics such as operating margins and returns on capital employed — just the sort of business preferred by star fund manager Terry Smith. Importantly, those that built the company from scratch also remain in post with sizeable shareholdings.

Third, Fevetree’s finances are in sound order with management expecting to report a year-end cash position of £128m in March. Many firms would kill for its balance sheet. 

Fourth, Fevertree doesn’t feature high up the list of those stocks currently receiving attention from short-sellers. That suggests even the most pessimistic market participants lack the conviction, at least for now, to truly bet against CEO Tim Warrillow and his team being able to turn things around. 

A final, admittedly speculative, reason is that Fevertree’s dramatic fall from grace makes it a bid target. Potential US suitors include beverage giants Coca Cola and PepsiCo. In the UK, Diageo — owner of gin brands Gordon’s and Tanqueray — could also be running the rule. 

On the other hand… 

The first reason I’d steer clear is the possibility we’ve reached ‘peak gin’ in the UK, at least based on the revenue growth stagnating. Like most things, specific drinks gain and lose popularity over time. Perhaps recent trading is the first indication of a reversion to the mean.

Second, there’s still no certainty the company’s performance in the UK can be replicated overseas where the popularity of a gin and tonic is arguably lower. Moreover, the trend towards premiumisation could slow if concerns over the global economy gather pace, leading consumers to switch to lower-priced alternatives, or avoid them altogether.  

A third reason relates to increased competition and the lack of an economic moat. With the aforementioned excellent margins, it was only a matter of time before more established rivals set out to steal market share back from the AIM-listed upstart. Even if the demand for mixers were to remain, there’s no guarantee fickle shoppers won’t gravitate towards other brands. 

Fourth, the potential opportunity cost of missing out on gains elsewhere must be considered. This is particularly relevant here given that Fevertree returns very little cash to shareholders. As such, investors might reasonably ask whether it’s worth waiting for a recovery if they aren’t being compensated for their patience.  

The final reason to avoid Fevertree rests on its valuation. Despite falling 60% from the highs reached in September 2018, the stock still trades on a lofty 30 times forecast earnings — mightily expensive for a company issuing profit warnings.

In sum, I remain undecided and that’s sufficient for me to stay on the sidelines for now.

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Paul Summers 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.

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