Scottish soft drinks company AG Barr [BAG] said on Tuesday that profits for the 26 weeks to 27 July 2019 would be 20% lower than the previous year, sending shares plummeting 28% to 623p and tarnishing the Irn-bru maker’s image as a business insulated from cyclical headwinds.
While soft drinks producers globally, including The Coca-Cola Company [KO] and PepsiCo [PEP], all face the challenge of the shift away from highly caloric carbonated drinks to a more health-minded consumer, AG Barr cited a slew of headwinds for its struggling results. From an unusually chilly spring and early summer, to a shortage of CO2, to the impact of the so-called sugar levy.
The fact that a Scottish company would blame falling sales on a late inset of hot weather has raised some eyebrows among City analysts, who see consumer staples as a textbook defensive sector mostly insulated from seasonal and cyclical downturns. “To say this is a curveball is an understatement,” wrote Nicholas Hyett of Hargreaves Lansdown. “Consumer goods companies like AG Barr are supposed to be reliable compounders, with sales that turn up come rain or shine.”
“To say this is a curveball is an understatement. Consumer goods companies like AG Barr are supposed to be reliable compounders, with sales that turn up come rain or shine” - Hargreaves Lansdown, Nicholas Hyett
But some brokers, like Investec, did concede that AG Barr faced a tough year-on-year comparison after the heatwave in Summer 2018, which pushed the company, by management’s own admission, to momentarily turn the focus on volumes.
Catching up with consumers
However, it’s not just the weather that’s causing problems for the soft drinks company, as it also faces secular headwinds from the consumers shift towards low in sugar products like iced tea and flavoured water.
While a competitor like Britvic [BVIC] can count on its portfolio of juices and fruit-flavoured drinks, AG Barr is squeezed on one side from American multinationals like Pepsi, whose coffee drinks and sparkling water helped sustain robust volume gains in the latest quarter, and upstart brands like Fevertree [FEVR] on the other.
In a note last week, HSBC analysts reduced their price target on AG Barr’s stock due to its high valuation – around 26 times trailing 12-month earnings before Tuesday’s profit warning – and instead named Fevertree as their top pick in the sector, thanks to its “compelling growth story”.
Indeed, analysts’ concerns centre around AG Barr’s stock valuation, which after Tuesday’s crash sits at 19.8 times TTM earnings, comparable to Britvic’s 19.48. In the aftermath of the profit warning, Numis analysts cut earnings forecasts for the next three years by some 21%, saying that shares are overvalued. They expect EPS of 26.4p for 2020, 27.6p for 2021 and 28.4p for 2022, compared to a Refinitiv consensus of 32p for the fiscal year.
“There’s little growth forecast at this stage,” Numis wrote. “We believe a more reasonable price-to-earnings ratio for AG Barr is 20 times,” in line with the company’s five-year average and implying a price target of 550p, which is still well below both current levels and a far cry from the average price target of 712p.
|PE ratio (TTM)||19.51|
|Quarterly Revenue Growth (YoY)||5.80%|
AG Barr share price vitals, Yahoo Finance, 19 July 2019
The profit warning may have proven to be a disappointment to AG Barr shareholders, but analysts are warning not to let it overshadow the company’s core strengths. “It’s important not to lose sight of some of AG Barr’s underlying attractions,” wrote Hargreaves Lansdown’s Hyett. “The group’s got net cash on the balance sheet which will help it weather the storm, and a loyal customer base for its core Irn-Bru brand.”
In fact, Irn-Bru was not caught in the sales downturn, which management said had mainly arisen from specific brands such as Rockstar energy drinks and Rubicon juice drinks. Those brands are headed, respectively, for a flavour expansion and a recipe revamp, which should help sales improve in the second half of the year, according to AG Barr. It also highlighted canned premium cocktails under the Funkin logo as “exceeding expectations”, giving the company a competitive edge over the likes of Fevertree.
“AG Barr has a good reputation of being able to deal with challenges such as the sugar tax, where it had to reformulate its products,” wrote Russ Mould of AJ Bell, adding that now that summer temperatures have fully set in, sales should start to pop.