Description

Elevator Pitch

Fever-Tree (Fever) is a consumer brand that essentially created its own category - premium cocktail mixers.  Fever has been met with strong demand in almost every market it has entered, driving explosive sales growth and market share gains in tonic and ginger beer. Fever has already achieved a dominant 45% market share in its home country (U.K.) and is now seeding the globe with its deliciousness.  It has compelling financial characteristics led by strong organic growth (five and ten year organic sales CAGR of 34% and 32%) with a long runway ahead.  It has an asset light business model with a return on tangible capital of over 100%.  They have grown free cash flow every year since IPO with no down years.  They have a strong balance sheet (Fort Knox baby!) with no debt and net cash equal to 10% of their market cap.  Despite their small size and high growth, they pay a dividend (1.9% yield), and even paid a sizable special divie a few months ago.  While top-line growth continues unabated, earnings have recently been hit by supply chain and cost inflation issues that have driven EBITDA margins from ~30% to ~10%.  Despite sales and other KPIs that point to a healthy brand, the margin weakness has driven the stock down a whooping 70% YTD, extraordinary for a consumer staples stock.  The supply chain and cost inflation issues should prove mostly transitory, providing a window of opportunity to buy this little gem at only 10x EPS (2024 normalized earnings ex-cash). 

Description 

London-based Fevertree Drinks is the world’s largest purveyor of premium cocktail mixers.  Approximately 80% of sales are tonic water (different flavors of tonic such as Elderflower, Cucumber, Lemon, and Mediterranean) with the remainder composed of ginger beer, club soda and other assorted non–tonic flavors (Sicilian Lemonade, Sparkling Grapefruit, etc.).  Roughly 70% of sales are off-premise (grocery stores) with 30% on-premise (restaurants, bars, etc.).  They typically sell in four-packs of cute little 6.8 ounce bottles for $5.99.

Fever-Tree was founded in 2004 by Charles Roll and Tim Warrillow.  Charles was a professional gin distiller.  Tim was a beverage industry consultant.  They wanted to create a product to ride the spirit premiumization trend.  They were originally going to launch a premium gin but saw a better opportunity for a premium mixer.  They thought, hey, if you’re spending all this money on a premium spirit, then shouldn’t you mix with a premium mixer?  Besides, when three-fourths of your drink is the mixer don’t you want to mix with something better than Schweppes out of a two-liter bottle or a soda gun?  That's just cringe.  And thus Fever-Tree was born.  They were essentially the first-mover in premium mixers.  Ten years after founding they came public.  

Fever-Tree’s DNA is spirits, not soda.  They were built by partnering with spirits companies to make the perfect gin & tonic.  They co-market in TV ads with the likes of Grey Goose.  They are distributed by spirits distributors.  They are consumed with alcohol.  The co-founders came from the spirits industry.  The current U.S. Fever-Tree CEO is the former CEO of Belvedere Vodka.  They are placed in the mixer aisle not the soda aisle.  They are all about the craft cocktail.  Their slogan is “when three-quarters of your drink is a mixer, mix with the best'', not “do the Dew” or whatever.  In other words, it's a very different type of non-alcoholic beverage company that identifies more with spirits than soda.        

Fever’s strategy has been clear from the beginning: 

1) Ride the coat-tails of industry trends: liquor premiumization and spirits taking share from beer & wine via the cocktail culture.

2) Use only the best ingredients - clean, all natural, nothing artificial.  For example, they use cane sugar or fruit sugar as a sweetener rather than corn syrup or artificial sweeteners.  They scour the world for the highest quality ingredients (quinine from The Congo, lemons from Sicily, raspberries from Scotland, etc).  How much of this is LaCroix-style marketing puffery I do not know, however, they come across as sincere and the stories they tell sound authentic.    

3) Win the on-premise market first to establish consumer brand awareness, then move to the off-premise.  If you are first to market and can win the on-premise market, you naturally win the consumer off-premise due to brand equity and brand recognition.  This is a difficult strategy but the right one to build a strong durable consumer brand.    

4) Innovate.  Fever-Tree gets high marks for innovation.  A steady flow of new mixers keeps the conversation fresh between reps and bartenders in the on-premise market, and keeps consumers coming back to the mixer aisle to see what's new off-premise. Occasionally something catches.  For example, they launched Sparkling Grapefruit in 2020 and it is now over 10% of sales in the U.S.  It’s primarily used to make Palomas (tequila and grapefruit) and is a hit.  Their elderflower tonic has also been a huge success.  They have even had limited edition mixers such as Blood Orange.  They create mixers around spirit and cocktail trends, and also to reduce their reliance on gin & tonic.  It is a push to capture share of a growing premium mixer market and a widening assortment of flavors across different spirits.  

Marketing spend runs around 10% of sales.  Fever co-markets a lot with spirits brands.  For example, in the U.S. they co-branded with Bombay for gin & tonics, they ran TV ads with Grey Goose for spritz options, and ran a “rum & cola “reimagined” campaign with Bacardi.  Co-marketing with premium spirits brands helps Fever build its brand.  Other forms of marketing are mainly focused on PR events such as the Kentucky Derby, Queens Tennis, and pop-up bars such as the one they had in Bryant Park.  This allows consumers to experience a variety of Fever-Tree flavors and cocktails and ask questions of Fever-Tree bartenders.  They opened their first airport bar in May of this year (in London) which has already served 60,000 cocktails, far exceeding their expectations.  They are looking at opening additional airport bars. 

Industry background

Prior to Fever-Tree, Schweppes dominated the market for tonic water with close to 100% share.  Unfortunately, they rested a little too comfortably, as you would expect of a 100-year old company with 100% market share to do.  Decade after decade of no innovation and stale packaging.  Also, they suffer from fractured ownership making management and decision making difficult.  All this helps explain some of Fever’s rapid market share gains out of the gate.  Schweppes was the perfect company to disrupt.  Fever is gaining extraordinary amounts of share across the globe due to an ill-prepared Schweppes.  After Fever took off, it literally took Schweppes 10 years to get a premium tonic to market.  There is still a lot of share for them to seed outside the U.K, where Fever has already won the market. 

Fever-Tree has clearly struck a nerve with the consumer desperate for something better.  All the KPIs say Fever-Tree has created something special.  They crush the competition on sell-through rate, they take market share at a rapid pace wherever they go, and they exhibit tremendous pricing power (typically priced 100-200% over Schweppes).  Every time they enter a market they expand the mixer category.  For example, the U.K. mixer market has tripled in size over the last eight years.  They are a classic disruptor and have redefined the category.  The key ingredients to winning this market are taste, image, distribution, and price.  Fever appears to be winning on all counts except price.  

What is the addressable market (TAM) for mixers?  It’s hard to say.  I’ve seen a wide range of estimates and they vary widely.  Also, the mixer category is growing fast as Fever-Tree essentially created the category for premium mixers and is driving category growth.  Here is what Fever-Tree had in their 2021 presentation:

Source: company reports

Keep in mind this is only the off-premise market, using Nielsen and IRI retail data.  Assuming off-premise is 70% of the total, the TAM including on-premise would be close to £4B.  And then add in robust 2022 category growth.  The mixer category grew 11% globally last year as Fever drives trends, category growth, and re-defining the category.  The penetration rate of premium spirits far exceeds that of premium mixers.  Lastly, I don’t believe the numbers above include non-carbonated mixers such as margarita mix and bloody mary mix, expanding the category even further (side note: they plan on entering non-carbonated mixers next year).  Morgan Stanley sized the total mixer market at £10B in their initiation piece from 2018. 

Regional Sales Overview

Fever manages the company in four regions and reports sales as such.

U.K

The U.K. is Fever’s largest market at 35% of sales.  Over the last five and ten years sales have grown at a CAGR of 40% and 34%, respectfully.  In 2021 sales grew 15% and are up 6% in 1H22 as they continue to recover from Covid bar/restaurant lockdowns.  U.K. sales grew 12-fold from 2014 to 2018 as the brand caught on during a time when gin doubled its share of U.K. spirits, from 10% to 20%.  It now dominates the U.K. mixer market with 41% market share off-premise and 50% on-premise.  Fever is now larger than Schweppes and 20x the size of the next largest premium mixer, Fentimans, with only 2% share.  Retail sell-through is 7x that of other premium mixers.  Operating out of only one bottling plant in the U.K. provides Fever tremendous scale and efficiency.  

Given its already dominant market share in the U.K., further significant gains are unlikely.  While they continue to gain share and extend their dominant position on-premise, overall growth will likely resemble that of the overall gin market.  The market has shown signs of slowing this year as the economy weakens.  Disposable income is under intense pressure due to high energy prices and overall inflation.  While Fever-Tree consumers are often hard core loyalists, they could begin to trade down.  Consensus expectations are for 2% sales growth from ‘22-’25.

Europe 

Europe is Fever’s second largest market at 29% of sales.  Over the last five and ten years sales have grown at a CAGR of 27% and 26%, respectfully.  In 2021 constant currency sales grew 35% and are up 31% in 1H22.  According to Nielsen, Fever is the #1 mixer brand in Europe.  Management's stated goal is to grow their European business 2.5x from 2020 levels over the medium-term (I take that as five years, so 2025), implying sales of $163MM vs. 2022e sales of $116MM.

U.S.

The U.S. is Fever-Tree’s third largest region at 27% of sales.  Over the last five and ten years sales have grown at a CAGR of 39% and 34%, respectfully.  In 2021 constant currency sales grew 41%.  Sales are only up 11% in 1H22 due to supply chain issues which have limited supply.  According to management, underlying demand is stronger than current sales indicate and should improve in 2H as they build inventory in the U.K. and ship to the U.S. to fulfill strong demand (more on this later).

The U.S. market is Fevers biggest opportunity.  The U.S. consumes 10x more in spirits than the U.K.  In the U.K. premium mixers have grown to ~45% of the mixer market vs. only 10% in the U.S. (and 18% in Europe), although Brits drink more gin than us Americans, so a comparable level of penetration may not be realistic.  Further, we drink a lot more dark liquors which pair with Coke.  Still, according to Nielsen, Fever has already captured #1 market share at retail in tonic and ginger beer in the U.S.  Their rate of sale at retail is very high and far ahead of other brands in the U.S., encouraging retailers to give them more shelf space.  Covid accelerated momentum with retail sales almost doubling from 2019 to 2021.  

All KPIs point to a healthy and thriving brand in the U.S.  Just through the first half of 2022 they have increased total points of distribution by 33% via winning high quality accounts such as MGM, Marriott, and Four Seasons.  Management’s stated goal is to grow the U.S. business 5x from 2020 levels over the medium-term, implying sales of $295MM vs. 2022e sales of $95MM.  Consensus is for 20% organic sales growth from ’22-’25 which seems about right.  

Rest of World

Rest of World is Fever’s fourth largest market at 9% of sales.  Over the last five and ten years sales have grown at a CAGR of 39% and 42%, respectfully.  In 2021 constant currency sales grew 20% and are up 7% in 1H22.  Australia and Canada are key markets where they are driving category growth. According to Nielsen they are already the #1 tonic brand in Canada.  

Stellar Financial Characteristics

Here are some numbers to salivate over.

*ROIC calc adjusts capital base for excess cash and accumulated intangible amortization.

As good as sales growth has been, 2020 and 2021 were hurt by on-premise Covid lockdowns and FX headwinds.  In the U.K. the on-premise market was shut down for half the year due to Covid restrictions.  In the U.S. FX headwinds weighed on reported sales which were reported up 33%, but were up 41% in constant currency.  

The five and ten year sales CAGRs are eye-popping.

*all periods ending are in consensus 2022e

They see a lot of growth ahead and outline some of the exciting opportunities below, such as their intention to enter non-carbonated mixers in the U.S. next year:

As shown above, Fever generates returns on tangible capital of over 100% due to its asset light business model. Capx is only $5MM.  It owns no manufacturing plants or DCs.  Raw materials - ingredients, labels, bottles, everything -  are shipped directly to the bottler.  The finished product is then shipped to the distributor who is responsible for getting it to bars, restaurants, and grocery stores.  While this asset light model leads to lower costs and higher returns, it also leads to lower visibility and makes it more susceptible to cost pressures such as the ones they are currently experiencing.  

Working capital is the primary use of capital which ran around 50% of sales pre-Covid and has run around 70% of sales during and post-Covid.  

Assessing the Margin Headwinds

The crux of the debate today is Fever’s depressed margins.  Fever-Tree’s mantra is 50% gross margins & 30% EBITDA margins.  They lived up to that mantra prior to 2020 but then margins began to decline and haven’t yet stopped. 

As you can see, we had eight years of pretty consistent margin performance before the wheels started to come off in 2020.  The decline in gross margins accounts for essentially 100% of the decline in operating margins.  From 2019-2022e Fever’s gross margin fell approximately 17 percentage points from 50.5% to 34.0% while its EBITDA margin fell by about the same.  So we can narrow our focus on just the gross margin as the source of the problem.  The issues impacting gross margins are:

1. U.S. supply chain issues

2. Cost inflation 

       3. Lack of scale in growth markets

        4. Pricing strategy (holding prices in growth markets despite high inflation)

Using management commentary and company filings the cumulative margin impact from these is:

Morgan Stanley has done good work here and provides a similar margin walk.  They estimate the U.S. supply chain/logistics issues account for 50% of the 1700 bps margin compression from 2019-22, with 600 bps coming from trans-atlantic freight and another 250 presumably coming from inflation and dis-economies of scale.  Management does not explicitly break out the margin impact from dis-economies of scale, but they do discuss it on their calls.  It is presumably mixed in with “logistics issues” and “cost inflation” (lack of scale = higher unit costs).

Let’s dig into each of these to assess how much margin can be recovered.

U.S. supply chain issues

Fevers supply chain issues are confined to the U.S.  Fever currently makes only 40% of their U.S. finished product locally (in the U.S.).  The remaining 60% is very expensive to source because it has to be shipped from the U.K.  The plan was to have 80% of U.S. production done locally by the end of this year.  Unfortunately they hit production snags.  They use two bottling plants in the U.S., one on each coast.  The West coast production line was commissioned in 2021 and the East coast was commissioned in 2022.  On the West coast they have had a difficult time sourcing glass bottles due to port congestion delays.  Securing glass supply on the West coast has led to both higher glass costs and higher freight costs, as well as incurring higher internal freight costs as they try to balance inventory between coasts.  They are working hard to secure glass supply in 2023 for both the East coast and West coast.  (Yes, there is a glass bottle shortage and prices are up a lot).  On the last call they said West coast port congestion has eased and production there is running better.  

The bigger problem has been on the East coast where a labor shortage has slowed their production ramp.  As a result, Fever is relying on their U.K. plant and shipping to the U.S.  This has resulted in extraordinarily high transportation costs and has left Fever vulnerable to skyrocketing trans-atlantic shipping rates which are up another 50% this year on top of the huge rise last year.  According to the company, U.S. logistics costs were up 56% per case in 2021.  They are up more this year.  The East coast ramp is by far the biggest headwind to margins.  Fortunately these are visibly temporary costs that should resolve themselves over the next 6-12 months.  We should see close to a full year of local bottling in the U.S. in 2023 which will dramatically reduce exposure to high sea freight & overall logistics costs. 

Not only have these issues hurt margins, they have also led to inventory shortages and had a meaningful impact on sales.  Management has noted U.S. demand is far stronger than what current sales imply.  They have recently been increasing production in their U.K. plant to relieve their U.S. inventory shortage.  Given the high transportation costs they will probably lose money on these sales, however, it allows them to sustain momentum.  With West coast production now running more smoothly and East coast inventory levels normalizing due to increased shipments from the U.K., Fever is anticipating a strong 4Q.  

For modeling purposes I assume they recover 80% of the U.S. logistics cost increases in 2023 as U.S. production ramps and U.K. to U.S. shipping declines.  This leads to a 700 bp gross margin improvement in 2023.  I assume they ramp from 80% to 100% in 2024 and logistics costs improve further, adding another 180 bps to gross margin in 2024. 

Cost inflation

Cost inflation has two components: 1) logistics and transportation and 2) product costs.  I assume some inflation will remain permanently while some will prove transitory.  Some will be offset with higher prices.  My model assumes 50% recovery of cost inflation by 2025 via a combination of lower commodity costs and higher pricing.  A lot rides on European gas prices because they drive logistic/transportation costs as well as glass prices.  

The 50% increase in sea freight rates has been the primary driver of transportation cost inflation.  It has been a huge headwind to margins, however, these costs will lessen dramatically as U.S. production ramps.  

Product cost inflation has been driven primarily by glass bottles, which are 30% of total product cost.  Glass prices are primarily a function of gas prices so they’ve had glass price surcharges tied to gas prices.  While improved port congestion has eased glass availability on the West coast, globally, glass availability across the industry has been restricted.  In order to secure glass for the rest of the year they had to agree to a double-digit price increase.  They are currently negotiating for 2023 glass supply.  It is unlikely glass costs will decline next year and will probably increase.  They have also seen ingredient inflation.  Sugar and such.

For modeling purposes I have built in an additional 150 bp headwind to gross margins in 2023 for inflation, partially offset by improved pricing adding 50 bps.  In 2024 I assume they recapture 50% of the 2019-2022 cumulative inflation impact via a decline in commodity prices and improved pricing, adding 380 bps to gross margin.  This is a big assumption that has some risk to it.  

Lack of Scale in U.S.

“...the diversification of volumes as we establish this network has temporarily reduced our economies of scale…. As we increase volumes through this network, especially in the US, we will recapture economies of scale.” - FYE21 presentation

U.K. operations are extremely efficient due to scale.  They have 45% market share and run everything from one bottling plant which accounts for 38% of total sales.  So margins are high and profits are maximized.  Contrast this to the 62% of sales outside the U.K. which is spread across the globe and supported by six bottling sites and three canning sites.  So, 38% of sales in the U.K. - one bottling plant; 62% of sales in the rest of the world - nine plants.  Establishing this global network to serve the diversity of volumes has reduced economies of scale over the intermediate term.  As volumes continue to grow, especially in the U.S., scale will improve, and with it margins. 

On-shoring local production in the U.S., Australia, and elsewhere is the biggest challenge to margins.  Bottler fees are volume based, as are a lot of other purchase contracts.  As the business scales, unit costs will come down and margins will lift.

Pricing Power

Fever-Tree typically sells for a 100-200% premium to the mass market brand, Schweppes, indicating huge pricing power and brand strength.  However, in some cases the gap between Schweppes and Fever has gotten too wide.  Those who remember Marlboro Monday understand the risks of pushing pricing too far.  In 2020 Fever reduced prices by 15% in the U.S. to help close the price gap between them and Schweppes.  That was the first indicator that they may have pushed price too far.  The second is this year.  While most of Fever’s peers are on their second round of price increases, Fever has been holding prices flat, leading some to believe their considerable pricing power is simply tapped out.  While I think there is some truth to this, I also believe management is trying to prioritize growth and is hesitant to do anything that could disrupt its momentum.  It is winning over customers and taking share at a rapid clip and management doesn’t want to disrupt that.  Makes sense to me.  Holding prices flat during a period of high inflation is a heavy cost in the near-term.  Longer-term, either costs come down, they raise prices, or they get squeezed.  This is a good place to note that management thinks very long-term.  Decades.  So they are playing the long-term game and don’t mind suffering through a period of flat pricing if it means winning the U.S. market long-term.  

Fevers' goal is to optimize price while maintaining an  “affordable premium product”.  Price strategy varies by market depending on growth.  In mature markets (the U.K.) Fever is priced at 140% premium to Schweppes and is taking 8% pricing in 2022.  In Europe it’s closer to 100%.  In high growth, less mature markets such as the U.S. the premium to Schweppes is closer to 250%.  It is in this market that Fever has kept pricing flat as they try to drive adoption and narrow the price gap.  They just completed an in-depth market-by-market analysis and plan to take pricing next year in certain markets.  I’ve built in only 50 bps of margin improvement from pricing next year - a fairly conservative assumption in this environment.

Summary on Margin Recovery

Adding up all the sources of margin recovery gets us to a 45.4% gross margin by 2024:

Can Fever return to 50% gross margins and 30% EBITDA margins?  I think it is unlikely in the near-medium term, although 25% EBITDA margins seem reasonable by 2025, and they should move higher from there as the business continues to scale.  My preference would actually be for them to drop their margin target and focus on winning the market. 

Bears argue that the margin degradation is structural.  We don’t see a case for this, but rather see most of the issues as transitory over the next 1-2 years.  Cost headwinds (glass bottles, ocean freight) should moderate as the economy slows and we normalize from the covid dislocation, and diseconomies of scale fade as they push more volume through their network.

As we outlined above we see gross margins improving from 34% this year to 45% by 2024-25, resulting in EBITDA margins of 25% vs. its historical 30%.  Assuming 10% annual sales growth and 25% EBITDA margins, EPS will equal £.72 by 2024.  At the current price of £8.76, less £1.65 in net cash, Fever is trading at a P/E ex-cash of 9.9x normalized ‘24 EPS.    

Brand Strength

Despite the margin headwinds there are many signs Fever’s brand remains strong.

1. #1 market share in the U.K. with 45% value share and growing, and with 51% share on-premise.  They are bigger than Schweppes despite being 2.5x the price.  They are 20x the size of the next largest premium mixer.  Sell-through is 7x higher than other premium mixers.  

2. Grew 41% in constant currency in the U.S. last year with total points of distribution increaesing 33%.  Already #1 market share in tonic and ginger beer.  

3. European sales are growing >30% and Fever is 6x the next largest premium brand.

4. Fever has maintained huge pricing power globally.

The Importance Distribution and Winning On-premise 

Distribution to the on-premise market is an incredibly important ingredient to success in this business.  While the off-premise TAM is far bigger, the on-premise market heavily influences off-premise sales because it builds consumer awareness.  The thought goes that if Fever can win the bartender on-premise, they win the customer off-premise.  Building a brand this way is difficult and slow, but is the right approach.  Once Fever wins an account, it's pretty sticky business.  The bartender has to have a good reason to switch. 

How do you get your product in tens of thousands of bars, restaurants, and grocery stores across the globe?  This takes on even more importance in the U.S. due to the size of the market and its complexities (liquor laws… yes, I know Fever-Tree isn’t liquor just stay with me).

In 2018 Fever signed a national distribution agreement with the largest spirits distributor in the U.S., Southern Glazers.  Southern has 35% share in wine & spirits distribution in the U.S. with a great portfolio of the largest and best spirits brands in the world, giving them a connection to almost every on-premise account in their territory.  In on-premise, you’re not selling to the consumer, you’re selling to the bartender.  The bartender is the gatekeeper.  And Southern reps don’t just distribute, they sell.  Southern doesn’t represent any other mixer brand.  This creates a high barrier to entry for any premium mixer company trying to enter the market because it would be very hard for them to distribute it without one of the major distributors. Southern isn’t going to distribute a competitor product because they are committed to Fever-Tree, and the second largest distributor in the U.S., RNDC (15% share), isn't going to distribute an additional mixer because they already have an agreement with Q, Fever’s primary rival in the U.S.  

If this sounds like a great deal for the beverage company, keep in mind the distributor is getting a 30% margin (common industry knowledge).  Spirits distribution is incredibly profitable (according to wiki Southern Glazers is the 11th largest private company in the U.S.).  And while Fever is a lower ticket for Southern, they make up for it in inventory turn.

How does Fever win in on-premise? Bartenders are always looking for better products to please their clientele.  They just want happy customers and a bigger check.  Upselling the bartender from Schweppes out of a soda gun to FeverTree out of a cute little single-serve bottle is a big part of the sale.  The pitch is exactly Fever-Tree’s motto “If three-quarters of your drink is the mixer, mix with the best”.  For example, vodka is flavorless so the customer tastes only the tonic.  Therefore go with something better than Schweppes.  While bartenders will serve you a gin & tonic with Schweppes out of the gun, no bartender feels good about that due to the lack of effervescence and the lack of theater.  Europe generally does not have soda guns so drinks have always been served by the bottle.  In the U.S, however, guns are pervasive.  When a customer is served their cocktail poured tableside from the sassy little Fever-Tree bottle, it creates theater and is a superior experience to schlopping a G&T served from a gun with no presentation.  And having the bottle displayed on the table is obviously a huge marketing tool that helps Fever grow brand awareness.  This is what Southern does - they try to win the bartender over.  If they can do that, Fever-Tree becomes a growing, recurring revenue stream.  

While in the on-premise market the distributor is the salesperson, in retail there is no one to market the product.  The packaging does the marketing.  If the consumer doesn’t know any of the brands they size you up by your price and your packaging.  But if they can win you over on-premise, it makes for a much easier sell in the grocery store.  Build the brand on-premise, sell volume off-premise.  This is the brand-building strategy of a spirits company.  Fever-Tree is building a brand like a spirits company.

Another point worth making here is if one of the big guys like Coke or Pepsi decided they wanted to enter the premium mixer market, they would have no natural distribution on-premise.  Yeah they can actually distribute a premium mixer, but they don’t have relationships with the bartenders and wouldn’t know how to sell a mixer.  Fever-Tree on the other hand is partnering with the spirits companies, co-marketing with them, and has Southern representing them in the on-premise.  Coke and Pepsi have none of that.  They don’t have reps pitching new craft cocktails.  Similarly, Schweppes is a cheap and easy solution for the on-premise, but their reps aren’t out talking to bartenders trying out new craft cocktails with new flavors.

“The national distributors have the scale to drive adoption at hundreds of thousands of on-premise accounts; bars and restaurants are crucial to build on the foundation of FeverTree’s brand equity.  This relationship in combination with Fever’s co-marketing agreements with companies like Diageo highlights how Fever-Tree behaves more like a spirits company than a typical consumer beverage business.  The consolidation and regulatory protection of the wholesale tier protects the moat for scaled suppliers.” -In Practise, September 20, 2021

Expanding into Adjacencies

Fever recently announced they intend to move into non-carbonated mixers in 2023.  These would mainly be margarita and bloody mary mix but also “bar essentials” such as grenadines and bitters.  The non-carbonated mixer market is larger than either tonic or ginger beer.  And there is no clear leader.  With Fevers brand equity they have an excellent opportunity to grow into this adjacency.  

They also recently announced they were testing expansion into “adult soda” by placing some existing products that are sometimes consumed without alcohol in the adult soda aisle of the grocery store.  They will maintain their price premium and stay in the mixer aisle, but expand the bottle size in-keeping with traditional soda bottles and add them to the soda aisle.  This strategy makes me a bit nervous, thinking it could weaken their brand and image, but of course the size of the TAM is multiples of the mixer market so maybe it's worth testing.  They are currently testing it in U.K. grocery stores.  By adding skus to the soda aisle they have already secured shelf space equal to a 5% increase. 

Valuation

With earnings temporarily depressed any valuation metric on current or even 2023 numbers is meaningless.  Let’s start by looking at EV/Sales and then move to valuation on anticipated normalized earnings.

As you can see EV/Sales(NTM) is super depressed at 2.25x, its lowest level by far since going public.  

In my opinion there is a ton of strategic value here for someone with global distribution, like Diageo.  Consider that Coke took a stake in Monster (somewhat similar to Fever in returns, growth, and its niche-y beverage profile) at 5.0x sales.  Here are a few other private market comps of niche beverages that are worth considering:

So purely on private market comps using EV/S Fever has more than 2x upside.  And Fever’s high margins argue for an above average EV/S multiple.  A large acquiror with a global supply chain and global distribution could solve many, if not all, of Fever’s current issues.  Most sell-side analyst’s actually comp Fever to spirits companies rather than soda companies.  The private market values in spirits are even higher at ~6.0x EV/S.

It’s worth spending a minute digressing here on Monster.  At the time Coke bought their stake in Monster in 2014 they were a distant second to Redbull in a beverage niche some thought faddish.  Today, Monster is the #1 stock in total shareholder return over the past 20 years with a return of 107,000%.  It is up over 4x since partnering with Coke.  The day they reported the Coke distribution and equity ownership deal the stock was up 38% and never looked back.  This speaks to the opportunity Fever has in partnering with a global beverage company to accelerate distribution.  The big difference in distribution is Fever needs someone that can sell into on-premise - a connection with the bartenders.  That would be a liquor company.  And it would have to be a company that has a brand in almost every spirit category because Fever would be abandoning co-marketing relationships with all other liquor companies.  Diageo has 48% share in gin and has a portfolio of brands across spirit types.  Seems like a good fit.

Now let’s look at normalized earnings and get to a value on P/E.

I start by modeling out sales by region for 2022-2024.  These are roughly in line with consensus.  You can see those estimates below which result in a ~10% sales CAGR to 2024.

Using the margin analysis from earlier, I model gross margins returning to 45.4% by 2024 and EBITDA margins of 24.7%.  While these margins are far higher than today’s level, they are conservative relative to the eight years prior to Covid.  It somewhat splits the difference.  These assumptions get us to £.72 in 2024 EPS as shown below.   

Ex-cash Fever is trading at a P/E of 9.9x these normalized EPS.  Public market comps are tricky but consider that National Beverage (LaCroix) trades 50% higher on EV/S and doesn’t have near the margin profile of Fever.  Fever is most comparable to Monster which has a similar history of high growth and returns.  It trades at 39x ‘22e earnings and 8.3 EV/S. 

I assume a fair multiple is in the low 20’s.  23x ‘24 normalized earnings plus £1.65 in net cash gets me to an estimated value of £18.21, or upside of 108% to 2024.

Competitive Advantages: 

First Mover - In the off-premise, Fever-Tree being first to market was an undeniable advantage.  Many consumers are now loyal Fever-Tree customers and they have to have a reason to switch.  If you are a Fever-Tree customer it's hard to find a reason to switch other than to downtrade for budgetary reasons.  And shelf space is limited. Fever provides the retailer with fast inventory turn and strong margins, hard for a newcomer to compete with.  

Distribution - U.S. distribution is highly concentrated with Southern Glazers and RNDC having a combined 50% market share.  Glazers carries Fever and RNDC carries Fever’s largest competitor, Q, and neither is interested in bringing in a second premium mixer.

Brand - All the KPIs outlined in this report - sales growth, price premium, sell-through rate vs. competitors, etc. point to significant brand equity.  The hard work Fever has put into establishing an on-premise presence has certainly helped build the brand.

Risks

Consumer spending 

The economy is obviously weakening which poses trade down risk.  Longer-term, maybe we are at the end of an era of conspicuous consumption and entering an era of repression.  This is a macro risk.

Brand vs. fad 

I fully acknowledge Fever-Tree could be some decade long fad and the investment gods are playing a sick joke on me.  I am reminded of all the flavored seltzers that came to market at price premiums and are now in the same low-price bin.  If things turn south I believe the stock price is supported by strong strategic value.

Competition 

Competitors are Schweppes, the largest mass market brand, Q, the second largest premium mixer brand to Fever, and tons of small competitors.  Every major grocery chain now has their own private label tonic so I don’t want to understate the competition.  While there is tons of competition in the space, we believe Fever’s first mover advantage, distribution, and brand equity create a sizable barrier to entry.  Bartenders need a reason to switch and it’s hard to find one, especially if they’re already using Southern for their spirits needs.  Q is Fever’s primary competitor in the U.S. They are in the same number of stores today, however, Fever’s sales per store is more than double Q’s at ~$250k vs ~$100k.  Fever has said they took considerable share from Q during Covid, and that their sell-through is 60-90% greater in stores where they have the same number of SKUs.  Also, Q is 50% club soda and 25% ginger beer.  There is room for both brands, witness Redbull and Monster. 

Pricing 

Relative to other food categories, Fever sells for a huge premium to the mass market brand.  It would be hard to find a category in the grocery store that exhibits such a wide spread between premium and mass.  Fever’s pricing power may be tapped out.

Alternatives

The explosive growth in legalized marijuana could take share from alcohol.  While they certainly aren’t mutually exclusive, pot provides consumers an alternative to get f*cked up.

My Favorite Fever-Tree Cocktails:

Fever-Tree Mediterranean Tonic and Hendricks gin, fresh squeezed lime wedge 

Fever-Tree Elderflower Tonic and Empress 1908 gin, lime wedge garnish

Fever-Tree Sparkling Grapefruit and Don Julio blanco Tequila 

DISCLAIMER: THIS IS NOT A RECOMMENDATION. The securities described are neither a recommendation nor a solicitation. There are no assurances that securities identified in this note will be profitable investments. The stated opinions are for general information only and not meant to be predictions or an offer of individual or personalized investment advice. This information and these opinions are subject to change without notice. Security information is being obtained from resources I believe to be accurate, but no warrant is made as to the accuracy or completeness of the information. Any type of investing involves risk and there are no guarantees. The author may or may not have material positions in the securities mentioned in this note and will not be obligated to give notice of any changes in their views or positioning. The author makes no representation or warranty, express or implied, regarding the accuracy, completeness, or adequacy of the information. The author accepts no duty of care to you in relation to investments. Past performance cannot be relied on as a guide to future performance.

Catalyst

Margin recovery as U.S. production ramps and inflation cools.