Description

I have written up the company on here before so I will try not to repeat a lot of descriptive narrative for the sake of padding out the report. In terms of what has changed from the last time I wrote up the company: 

·         Stills portfolio has continued to struggle – volumes have declined about 1% on average, while pricing has been a negative. Cordials have not really been a growth area, while Fruit Shoot and J20 have continued to lose ground. Contribution decline is about double the revenue decline

·         Carbonates continues to do very well as Pepsi Max has continued to take market share from Coke – from 2015-19, volume gains have been about 2% per annum and pricing (ex-sugar tax) has added another percent or so.

·         France has stood still, with volume declines (driven by private label weakness) being offset by pricing

·         Ireland is back to growth

·         In other international markets, they have thrown in the towel in some of the smaller markets for them where they lack scale, such as India. In the US, the Fruit Shoot multipack campaign was a failure, which they have discontinued, while they still participate in the single serve part of the market. In Brazil, In Brazil, they have added to their footprint via another acquisition, and Brazil is now about 8% of revenues 

Elsewhere, they announced a large capex plan in 2016. The purpose of the capex was to consolidate their production into three lines in the UK, and to modernise the production so that they could easily switch to multiple bottle sizes, which they could not do before, which has been helpful with the pricing architecture. Capex peaked at about £150m in 2017 (from just over £50m in 2015) before normalising again this year at a bit under £70m. The plan was a bit unpopular at the time as it depressed FCF and meant that the stock screened poorly, but as the capex wound down and the cash generation became more apparent, it drove a strong rally in the shares last year. The timing of my exit on VIC was poor, as I was a bit too quick to exit on that rally, and it proved to have more legs that I had anticipated at the time. 

The CEO, Simon Litherland, is still in charge of the company, while the CFO left about a year ago for a better opportunity at ASOS (probably wished he’d stayed put now). I suspect that, prior to Covid19, the shareholder register started to fill up with hedge fund attracted to the improving free cash flow. There were a few suspiciously timed broker notes pointing to the free cash flow with some helpful suggestions from the brokers on what to do with the cash and how undervalued the stock looked at the time, so I can imagine the conversations that were had. 

This year, the shares are down about 20%, while the decline from the highs is about 35%. There are two reasons for the decline 

First, about half of the UK business is on-trade, which is obviously at zero now. They pick up a bit of that via take home, but they will not get back all of it. In terms of the trajectory on that part of the business, clearly it is a call on how deep the recession is going to be and when economies start to get back to normal. This topic seems to be the subject of a holy war on the VIC message boards at the moment. I don’t particularly want any discussion on this idea to become an extension of that war – my view is bad recession this year, gets better into year end, reasonably smart snap back next year. I have volumes across the business -20% in H1, -15% in H2, and then a snap back next year. If you think I am a hopelessly optimistic buffoon with no clue on how bad this recession is going to be – fair enough – this idea is not for you. The company have laid out that every month of lockdown is about £15m off the EBIT – I have IFRS EBIT declining from £214m last year to £126m this year – I think it is conservative enough, but we will see, I guess. 

Second, the balance sheet is somewhat levered (see numbers at the top of the writeup). Net debt to adjusted EBITDA was 2.1x at the end of 2019, with covenants at 3.5x. I think it will peak at about 3.3x, so they should be okay. They have no significant maturities until 2024, and access to ample liquidity, so I would be surprised if there are balance sheet issues. 

The investment case here is really that I think that this year is going to be a write off, but I think that the business and the balance sheet are resilient enough for them to see it out, and that next year should be a better year. I have included some screenshots from my model below, but I think that the sales should be back up above the 2019 level by 2022, at which point the adjusted EPS should hopefully be north of 60p, and the FCF should recover to about £185m. 

I think that 10.5x P/E and a 10% FCF yield more than adequately reflect the risks the business faces over the next year or so. My fair value is 950p, which is about 15x 2022 earnings and would represent an 8% FCF yield. Pre-covid19, the three-year range on P/E was about 12x-17x, while the peers traded well above that. The company generates an ROE above 20% and a ROIC in the low to mid-teens, while there is some small amount of growth, so I don’t think 15x is overly demanding. 

Catalyst

None