Britvic Plc BVIC
October 07, 2015 - 3:22pm EST by
darthtrader
2015 2016
Price: 690.50 EPS 44.3 50
Shares Out. (in M): 261 P/E 15.7 13.9
Market Cap (in M): 1,188 P/FCF 29.5 20.4
Net Debt (in M): 404 EBIT 258 288
TEV: 1,592 TEV/EBIT 14.6 12.9

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Description

My apologies in advance for the horrendous formatting

Company At A Glance

 

 

 

 

 


 

Quick Investment Case

 

 

Britvic is a stable, value creating and cash generative company – it has generated decent returns on invested capital of ~14% over the economic cycle,

and should deliver a minimum of £65m of free cash flow this year, rising to around £85m next year and £110m-£120m by 2018 as sales growth and

operating margin expansion discussed below play out. I think they should be able to deliver steady 2%-3% organic revenue growth over the medium-term,

underpinned by pricing power in mature markets and very strong volume growth in international markets, as their Fruit Shoot brand, so proven and

successful in GB, is rolled out into international markets, most notably via the launch of the multipack product format in the US in 2016. Pricing in mature

markets, together with a tailwind from declining commodity prices of £18m-£30m (1.3%-2.2% of sales), potential for further cost cutting, and better cost

absorption in the international business (currently operating at an EBIT loss vs. 12-13% margins at the group level) should underpin adjusted operating

margin expansion from 11.8% in 2014 to 14.2% in 2018E, driving 2014-2018E adjusted EPS CAGR of 9% and 2018 EPS of 58p. A broad sector forward

P/E of 19x would imply a blue sky price target of 1100p by 2017 y/e, ~65% upside including dividends (currently yielding 3.5%). Even assuming a sector

discount of 20% (stock has historically traded at a discount) would imply 35% upside including dividends.

 

Company In Brief

 They are a soft drinks company mainly active in the UK until a few years ago, after which time they expanded inorganically into France, before further

expanding internationally, most notably into the US and India; they recently made an acquisition in Brazil, which should further diversify them geographically.

The business is split between brands they own themselves and those they bottle for a partner under a long-term contract.

 

 

Among the brands they own, the most famous ones in the UK are Robinsons (fruit dilutes), Fruit Shoot (kid’s fruit-based drink) and J2O (adult’s fruit-based

drink). Fruit Shoot is also the flagship brand in international markets. In France, the most well-known brand is Tesseire, a brand they have grown effectively

and are now rolling out modestly in the UK. They also own a water brand, Ballygowan, which is really an also-ran in the UK water market.

In terms of bottling and distribution for others, that is mainly in GB and Ireland, where they have a contract with Pepsi out until 2023. The contract allows

them to buy concentrate from Pepsi at a fixed price which rises by CPI less a certain amount (not disclosed) each year (floored at 0), while marketing costs

are split 50/50. Britvic are one of the more successful Pepsi partners – while in most European markets, Pepsi’s market share is around the 10% range, in

the UK it is nearer to 25% (according to the company).

 

 

The company has historically shown the stability in returns that one would expect in such a business, with return on invested capital in the range of 12%-18%,

with the exception in 2010 when the company took impairments on their Irish business.

 

 

 

The company has a current market cap of £1.7bn, while net debt of £618m (including my estimate of £200m for the defined benefit pension scheme

underfunding) leaves the enterprise value at around £2.3bn. The company is leveraged, but not excessively so, in my view, given the stability of the business –

the £618m of net debt is around 3x my forecasted adjusted 2015 EBITDA of £211m. The company can theoretically delever around 0.4 turns per annum,

should they choose to do so.

 

 

 

The company is led by Simon Litherland, who joined the company in 2011 and took the top role in 2013 after 20 years with Diageo in various roles. He came

into the CEO job after an expensive Fruit Shoot product recall cost the former CEO his job, and a subsequent attempt to merge with AG Barr and put their CEO

at the head of the merged entity was torpedoed by the UKCC, effectively handing him the CEO role by default. Since his appointment the shares are up about

60%, partially as a consequence of the continued bull market, partly due to his delivery on a £30m cost saving programme. He owns 35k shares, while the CFO

owns considerably more, around 245k shares.

 

 

 

The reporting divisions are currently GB Stills, GB Carbonates, France, Ireland, and International. Following the recent acquisition of ebba, Brazil will probably

also be reported separately going forward.

 

 

Business Detail 

 

 

GB Stills

 

 

 

The name is fairly self-explanatory – these are their own brands, mainly non-carbonated, The key brands in the division are Robinsons, Fruit Shoot and J2O.

 

 The GB squash market is about £775m, o/w £265m On Premise (bars, pubs, restaurants), the rest Grocery. Britvic’s market share fluctuates between high 30’s

and low 40’s, with the main competitor being supermarket private label. Those numbers include both VAT and retailer margin (60%-70% for On Premise, 30%

-40% for Grocery), hence assuming 38% market share (they have been losing share as customers trade down but talk about seeing recovery based around

reformulation, marketing and innovation such as their SQUAUS’D caps), that is a £165m revenue stream for them.  

 

 

Fruit Shoot is £150m-£175m of revenues, split £100m in Grocery, £50m-£75m On Premise (you get them in McDonalds, KFC, etc in the UK). Their share of this

market, as they define it, is about 20%, with Capri Sun about 25%, Ribena 10%, the rest private label - Fruit Shoot is positioned at a higher price point as the

higher quality product – you get an 8 pack of Fruit Shoot in the Grocery channel at about the same price point as a 15 pack of Capri Sun.

 

 

 

The rest of the division is, I believe, mainly J2O.

 

 

 

Revenue and margin profile (forecasts included) are as follows:

 

 

 

 

 

The large volume movements in 2012/13 are related to the Fruit Shoot product recall, due to bottle caps being found to be unsafe, followed by restocking

in 2013. Volumes and LfL were weak in 2014 and the first part of 2015 (-2.7% volume, -4.2% LfL  in H115– not shown above) mainly due to their weak

presence in water and trading down which impacted Robinsons. Volumes and overall LfL have since recovered a little in Q3 to +2.5% volume, -0.7% LfL,

driven by:

 

·         An easier comp in H2, with H214 -8% volume and -4.8% LfL vs. H114 -1.7% volume and +2.2% LfL – I f/c volumes +2.5% and pricing -1.0% in H215

·         Continued rollout of new products such as Tesseire (successful high end French product priced at a significant premium to Robinsons) and SQUASH’D

(strong concentrate in a package that fits in the pocket to add to bottled water and tap into the “on the go” market)

·         Revamp of Robinsons, including reformulation (aspartame out, sucralose in - so far tested well), adding new flavours, pack redesigns, together with

a marketing push

 

Overall I think that the company has shown in the last ~5  years that they have the ability to deliver pricing in stills (average YoY growth has been ~2%), which

 

I think underpins my LfL assumptions over the medium-term of +1.5% supported by brand equity in Fruit Shoot/Robinsons and a recovering UK consumer. I

don’t see a big opportunity to take price, particularly in Robinsons and J20, but the investments they have made in brand, together with a recovering consumer

and a UK food retail competitive environment which hopefully will not deteriorate meaningfully from what is already a highly competitive level, would underpin

the assumption that if they have delivered ~2% pricing on average in an already difficult environment, hopefully they can do at least that going forward. I forecast

continued volume declines of -0.5% pa over the medium-term – the company are more optimistic, but the key issue is their lack of presence in water, which is not a

problem I feel they can solve.

 

Declining contribution margins this year are largely driven by the increased A&P referred to above – as that generates renewed brand engagement and the

marketing spend normalises, I see the associated operating leverage driving a margin turnaround in 2016. Over the medium-term I see a very marginal expansion

in the contribution margins (10bps-20bps per year) as the most likely outcome. LfL growth of 1.5%, on average, driven by pricing, is obviously a tailwind for

margins, however I model some continued modestly elevated investment in A&P, which I think would be needed to drive the pricing.

 

GB Carbonates

 

This is the bottling agreement with Pepsi – it is mainly cola (I estimate 70%-80% of divisional sales, though they do not disclose this), with the tail being made

of brands such as Mountain Dew, Tango, 7up, and R Whites. The bottling agreement with Pepsi runs until 2023 and is basically Pepsi selling them a license.

They buy concentrate from Pepsi at a fixed price which rises by CPI less a certain amount (not disclosed) each year (floored at 0), while marketing costs are split

50/50.

 

The GB cola market is about £3.5bn, growing quite slowly at very low single digit, split about 50/50 between On Premise/Grocery. It is characterised by fairly

aggressive competition, with CCE being promotional in the full sugar part of the market in particular pretty much all of the time. Nonetheless Britvic have executed

well, driving pretty consistent market share gains over the years (mainly driven by effective marketing – one anecdote related to me by the company was that in

surveys done last summer, consumers in had the impression that Pepsi were sponsors of the World Cup due to their effective sport/music tie-ins, whereas in reality

Coke were the sponsors). The UK is now Pepsi’s best market with a 25% value share, which has been steadily increasing over time, with volume in particular

accelerating last year as CCE engaged in revenue management, ceding share:

 

 

Over the medium term, I expect the revenue growth to moderate a bit to +2.0% - there’s a finite amount of market share they can take from CCE without them

responding aggressively, while a couple of percent pricing is about as much as I see them taking – once Pepsi gets to about 85% of the price point of Coke over

the medium-term, it runs into a natural barrier.

 

 

France

 

The French business was acquired in 2010 at a price of €237m, which was 9.6x EV/EBITDA at the time (much less post-synergies). It was formerly called

Fruite Entreprises SA. The business has a presence in both syrups (Teisseire (#1), Moulin de Valdonne  (#2)) and juice (Fruite, Pressade). Since the acquisition,

I estimate Britvic have been able to drive organic CAGR of ~4.0%, with the company claiming an increase in market share overall of 160bps and double the

market growth rate. At the time of the deal, the company was strong in its market niches, but had little financial flexibility to invest behind the brands. Britvic

have been able to generate above market growth by:

 

·         Rolling out Fruit Shoot in France quickly

·         Investing more to bring innovation (i.e. successful Tesseire “pump” product)

·         Intelligent marketing (i.e. association with the Tour De France in a similar relationship to Robinsons/Wimbledon)

·         Managing the brand equity better to deliver strong pricing while taking market share

 

A very strong currency headwind, together with a slight cost/revenue mismatch (since addressed) has meant that the contribution growth has been quite limited:

In terms of my forecasts of 1.8% organic growth this year, accelerating to 2.2% next year and 2.0% over the medium term, I feel it is underpinned by what they have

delivered historically, combined with the 1.5% organic they delivered in H115 and the 8.7% volume growth they delivered in Q3, driven by continued Fruit Shoot

growth and the company taking market share.

 

Ireland

 

I have less to say about Ireland. It has been a failure. The business was bought pretty near to the top of the market in 2007, when they paid £170m in cash – as

of 2014 it was delivering a contribution of £47m and probably EBIT of £15m or so on an optimistic assumption, probably a bit less. The business is similar to the

GB stills and carbonates business (they have the Pepsi distribution agreement in Ireland, too), while they also operate a wholesale business too.

 

The business has suffered from the general economic malaise in Ireland, characterised by pub/club numbers continually declining, while value seeking by

customers has seen a persistent trend of price and volume declines, exacerbated by currency translation impacts, which ultimate ended in a sizeable goodwill

writedown a few years ago:

The incoming CEO restructured the business in 2013-2014, shutting a warehouse in Belfast, combining GB/Ireland management teams, simplifying support

functions and separating the licensed wholesale business from the core branded business to improve transparency. Despite the revenue headwind, they have

done okay in terms of protecting margins.

 

The business finally returned to organic growth in H115 of +2.5% (though pricing pressure remained a feature), decelerating slightly to +0.5% in Q315. I

am going for modest organic growth over the medium term of about 1.5% from depressed levels – there might be downside risk there but I don’t see it as

material to the investment case and they’ll hopefully get a bit of an assist from a recovering Irish economy.

 

The company, when justifying their Brazilian acquisition (below) point to the success they have had in France in terms of buying a business and driving

top line growth via better brand management and cost efficiencies – investors will be hoping that the Brazilian experience is more like the French one

than the Irish one.

 

International

 

International represents their efforts to internationalise the Fruit Shoot brand and includes a number of different markets, including the US, India,

Netherlands and Spain, but probably the part that moves the dial for investors is the US. As of 2014 y/e, divisional sales were £58m (of group sales

£1.3bn) while contribution was £20.3m. On a EBIT basis the business is operating at a loss as they have been investing in both A&P and infrastructure –

as an example, I believe that in the US they are currently nearly sized to deliver into both the single serve and the multipack markets while only actually

participating in the single serve market. They plan to expand into the multipack market in 2016, which is around 10x the size of the single serve market.

 

In terms of the US expansion, it has been a slight source of frustration for the last few quarters, with the entrance into multipack pushed back a bit

from 2015 to 2016. While they have been present in the single serve segment since 2012 when they signed a distribution agreement with four Pepsi

bottlers to distribute in 8 states to a few thousand distribution points (they now have national coverage), the really attractive market is probably

multipack. The company estimate that the single serve market is around $200m (£130m), while the multipack market is $2bn (£1.3bn), over 10% of

the size of the entire GB soft drinks market.

 

While the delay in coming to market has been questioned by analysts on numerous conference calls, my view is that it is a great opportunity, and

if they can execute on it anywhere like as well as they have done in the UK with their brand or as the bottling partner of Pepsi, then it is worth waiting

for. The delay is simply to do with choosing the optimal route to market, with the options being direct distribution (probably too expensive), using

Pepsi warehouses, or going to market via a broker such as ASM, Obviously, while the market is quite focused on the timing of the rollout, the

opportunity is more of a medium-term strategic one, with limited profits to come in the next couple of years, and the most important thing is that

they get the model right rather than doing it quickly. They are finalising their analysis of the options at the moment – I would say that the CEO has

so far proven himself to be good operationally, for example:

 

·         Closing factories in Chelmsford & Huddersfield where they were not getting high enough utilisation, generating savings

·         Transferring production capacity to France in 2014 to save on logistics costs and support margins

·         Improving procurement across the board

 

In short, I am confident in their ability to make the right choice in terms of route to market in US multipack, and the experience with demand in

the UK, France, and US single serve would seem to support the view that the latent demand for the product is there.

 

In terms of the value that the opportunity can bring to shareholders, I think that the right way to look at it is to consider the profit generation

opportunity a few years out, once the product has been pushed out into the market and momentum has been given time to build. I have made

assumptions based upon how things may look in 2020, assuming the current $2bn market grows 2% pa:

So the opportunity could potentially be worth 100p/share in present value.

 

The US Fruit Shoot multipack rollout, together with some modest progress in the Indian business, generates the following divisional forecasts,

which I see as very achievable:

Brazil

 

The entry into Brazil was announced a couple of months ago at the interims – they will acquire ebba, for R$ 580m, or £121m, with half

deferred for two years, in a 100% cash deal financed by a rights issue which has already been completed. The company is the 7th largest soft

drinks company in Brazil, the rest being large multinationals, while Brazil itself is the 6th largest soft drinks and dilutes market globally, and the

number 1 in just dilutes. They have a presence in dilutes via Maguary (31% share, also 10% share in ready to drink nectar) and the value-

focused dafruta (20% share). They think that the addressable market grows about 6% annualised out to 2020, about double the global market

growth. In terms of numbers, last year ebba generated R$437m revenue, R$33m EBIT.  The guidance for this year is revenues R$ 415m,

EBIT R$27m.

 

Britvic management have been looking at the deal for the last couple of years and have travelled to Brazil 4-5 times prior to the acquisition –

the timing appears to be driven by the implosion of all things Brazilian this year – management are of the view that it is a headwind for a year

or two more but the longer-term opportunity is there. In terms of the longer-term opportunity, the company see the 2015 EBITDA of ~R$40m

at least doubling by 2020, and the company fleshes that out roughly as follows:

 

·         Cost savings of R$10m to come from purchasing, supply chain – the savings have been quantified by the integration consultants

that 3G usually work with

·         Initially invested in infrastructure and A&P to drive longer-term growth and operating leverage

·         Introduction of Fruit Shoot into Brazil in the next 18 months at the latest drives operating leverage

·         Potentially enter new sub-categories to drive operating leverage

 

The pre-existing local management team will stay within the organisation to manage the process, and the business will be a separate reporting

unit.

 

The shares took a bit of a dive in the weeks following the announcement of the deal. I think a chunk of it was of course driven by the market

correction, but certainly some of it was driven by the deal itself, namely concerns over:

 

·         Timing – guidance calls from Brazil revenues down this year, flat next year and then gradual improvement in sales and rapid

improvement in profitability 2017 and beyond – could of course be pushed out if the economy continues to struggle

·         Structure – financed via a rights issue when the market felt they could have taken on more leverage to minimise the EPS dilution

·         Earnings impact – deal is only EPS neutral in year three

 

I’m not an expert on Brazil, but IMHO they probably are a bit too early (but of course they are looking longer out than me); in terms of the

earnings impact, it is a bit disappointing but I see it driving earnings potentially over a longer period if they can execute in Brazil anything

like they have done in France – hence from a DCF perspective, it shouldn’t impact the valuation too much. The financing is a bit perplexing

given they probably could have taken on the debt to do it without much difficulty, but the dilution is not huge.

 

For the record, I see the company beating their guidance of EBITDA at least doubling by 2020 – I see it up by about 150% from depressed

levels as spending behind the brand and Fruit shoot roll out drives 8%-9% top line CAGR – as operating leverage and some cost rationalisation

drive EBIT margins to around the group average, I see that driving EBITDA +150%:

 

I have the revenue growth picking up from 2017-2018 as the marketing investments they plan to make from now onwards start to bear fruits,

while the rollout of Fruit Shoot should also start to gain some momentum by then. On those numbers, they would (finally) beat their cost of

capital 4-5 years after the deal, and for it to be value creating, you’re dependent on them achieving what I set out above and then generating

steady low to mid-single digit mid-term growth:

 

 

The valuation work above (i.e. £14m of EVA) is notable for the fact that all of the value comes in the out years where the certainty around

forecasts is low, while it is also a bit aggressive I guess to use the group WACC. All the same, what stands out the most to me is that if the

deal works, it might be worth 1% on the current share price, if it is a total bomb then the rights issue was 5% of the market cap. Of course,

the real bear case would be that it turns out to be difficult and distracts management attention from the rest of the business, but overall the

company view when I spoke to them seemed to be if it works, it helps to diversify their revenues a bit and adds some shareholder value, if

it proves to be challenging, it probably cannot torpedo the investment case.

 

Brief Financials

 

I’ve laid out all of the revenue and contribution drivers by division above, but the high level summary on the revenues is as follows:

 

 

The fixed cost development (details laid out below), which I view as conservative as they assume costs growing about in line with

revenues, which may not be the case due to the operating leverage that should eventually manifest in the International business,

would drive the income statement as follows:

 

The earnings that they guide on and consensus works from are in fact not IFRS earnings but adjusted earnings:

The differences are mainly related to restructuring charges and amortisation (validity of both is questionable). In my forecasts, I continue to

assume a few million of restructuring charges per year. I think it is reasonable to expect this, as the company have hinted at further efficiencies

to be had, but of course if they are an ongoing thing then they are not an exceptional.

 

Historically, the exceptionals have been larger, driving a large gap between adjusted earnings and IFRS earnings – year by year, the charges

were as follows:

 

·         2010: £128m – mainly impairments on Ireland - £90m intangible, £15m tangible, some restructuring charges

·         2011: £20m – more restructuring charges in Ireland offset by some pension curtailment gains

·         2012: £6m – more restructuring in Ireland plus head office relocation expenses (I have been there and it is not lavish)

·         2013: £21m – two factory closures and associated redundancies in GB, cost of failed AG Barr merger

·         2014: £10m – final part of the GB restructuring

 

Most of my valuation work is done off of the IFRS numbers (with the exception of the target P/E approach).

 

Looking back over recent years, the company has averaged FCF of ~£70m per annum, (OCF 100% of adjusted EBIT, FCF 50% of adjusted EBIT);

the FCF has been used to pay dividends (current yield 3.5%, dividend CAGR 5.3% since 2011) and delever the balance sheet:

 

Detailed Investment Case

 

I will not labour the point made in the comments and detail above, but my overall thesis is that the company can grow adjusted

EBIT from £158m in 2014 to £168m this year to £216m in 2018, which would translated to adjusted EPS of 44.3p in 2015, 57.8p

by 2018. That translates to margin improvement of 240bps over the period, from 11.8% to 14.1%. I believe that the

company are broadly in agreement with my numbers and thinking, and have hinted at this when I have met with them.

 

The reason that I refer to 2018 adjusted EBIT is that, in my view, this is the right way to look at the business. I realise it is not

appropriate for some investors, but when they are making investments in margin now that will pay dividends in the medium term

(eg. margin dilutive investment in loss making International businesses that will generate operating leverage in the out years,

acquisition and restructuring of Brazilian business), one needs to account for this properly. This is actually another source of

opportunity, as most of the broker reports naturally focus on the 1y forward P/E (where actually it still looks inexpensive):

Britvic sector discount; source: GS report

 

I lay out the EBIT bridge for how I am getting from £158m to £216m below:

Cumulatively, I see £83m coming from price. I have talked about that in the notes above, but to recap, I see:

 

·         UK Stills delivering about 2% pa, in line with history and reflecting the marketing efforts that have been made in

the last 12 months

·         GB Carbonates delivering about 2% pa, in line with historical trends

·         France delivering about 2% pa, again in line with historical trends

·         Ireland delivering about 0.5% pa as the economy continues to recover

·         International & Brazil delivering 2%-3% per annum, slightly conservative vs. historical trends

 

I see volumes delivering £21m cumulatively, driven by about 1.2% average pricing and applying business unit contribution

margins – of that £21m, about 2/3 comes from the international Fruit Shoot rollout – we should see an announcement on

that towards the end of 2015, and I am optimistic it will be a success.

 

Currencies will weigh about £5m on the EBIT progression.

 

Fixed cost inflation takes about £35m off of the EBIT – I actually think that may be a conservative estimate as it implies

fixed costs growing at the same rate as the top line – I think the top line can grow faster and they can generate more leverage,

mainly due to the infrastructure being relatively built out in the US, which I referred to above. I also think there are potentially

areas where they can continue to economise – management share this view and commented thus on a recent conference call:

 

“In terms of other areas, we continue to identify cost efficiencies, to some degree taking out costs but to another degree, making

sure that our investments are working harder for us. One example is where we are actually making sure that more of our A&P

spend actually gets in front of consumers on air, etc.  Secondly, there are further opportunities, we believe, in supply chain.

We have talked previously about the new PET line in Leeds, which is by some way the fastest, the most efficient and, importantly,

the most flexible line that we will have in the company. That can create greater cost efficiencies for us and we are going to look

hard at whether or not there are other opportunities elsewhere that we can take advantage of with that.... Therefore, whilst

we have not officially guided to margin, we can already see where there are significant opportunities for us.

 

It is interesting that the company include the following slide in their recent investor presentation:

When I questioned them on the slide in a recent meeting, they commented that they would be disappointed if they did not

end up at the margin of companies F & G (around 15%) in the medium term – that would be in line with my estimates.

 

Other factors then take about £6m from the 2018 number. Within that -£6m number, there is a tailwind built in from commodities,

offset by more investments in A&P, mainly in the International business, where management have prepared the market for further

investments in the brand to build awareness. Of the £30m cost savings that they realised in the restructuring plan enacted when

the new CEO took over, £10m was invested into the International business yearly, which may go on for another couple of years.

Against that, they have commodity costs of about £600m pa – obviously commodities have gone through the floor, though they do

not see all of this for various reasons. Management guided me to a total 3%-5% tailwind to come over the next year or two, if

commodities stay at current levels, generating a ~£24m benefit.

 

If they can deliver roughly what I expect, you would see an adjusted EPS CAGR of ~9% 2014-2018, for adjusted EPS of 58p by 2018.

The broad  sector 1y forward P/E is roughly 19x, and the stock has traded at a 20% discount to the sector on average (range is 5%

to 40% discount), which would indicate a rough price target by 2017 year end of 57p * 19 * 80% = 900p = ~30% - including

dividends you get to about 37%, i.e. an IRR of ~18% with little risk, in my view.

 

The low risk point is debatable, but I see the dividend yield, and the balance sheet deleveraging (from an already not aggressive

debt position) as supportive to the investment case.

 

Valuation

 

I have laid out my multiples-based approach above, which gets me to about 900p (excluding dividends) of fair value at a historical

sector discount. A DCF-based approach (with the usual GIGO health warnings) yields a similar results: