Fever Tree: Gross Margin Outlook

In Practise Analysis

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In November 2014, Fever Tree (FEVR) listed in the UK at a valuation of ~£150m. With 50%+ gross and ~30% EBIT margins, UK long-only funds basked in its asset-lite model.

One overlooked detail in the roadshow was its bottling setup. At the time of the IPO, FEVR outsourced all production to one bottling partner in Somerset, UK. It sourced ingredients, glass, and packaging, and sent it all to one bottling plant. And this bottling partner was a real partner: the company actually owned equity in FEVR.

One of the great things Fever-Tree did in the early days, well before the IPO, they formed a very good relationship with the bottling firm they still use in the UK. That firm invested in Fever-Tree at a price well below, between 5% and 10% stake. The business was valued less than the IPO price, so it was a true partnership. A couple of the directors of that business were directors – if it was that formal a type of word – certainly advisors on the pre-IPO board. It was a real partnership with real mutual interest. - Former Director at FEVR

Not only did this align incentives, but it enabled FEVR to benefit from great economies of scale. All of FEVR's exports were served from one bottling plant in Somerset.

As FEVR scaled to the US and EU, it needed more capacity. Today, the company has ten bottling and canning sites. As more volume is spread over more sites, gross margins have declined.

Over the last 6 months, FEVR has cut guidance twice and now expects a gross margin between 33-35% in FY 2022, down 8% from 2021 and 17.5% from 2019. This leaves FEVR in an interesting position; its brand seems as strong as ever yet margins are the lowest in its public history.

There are various data points that suggest FEVR’s brand is as strong as ever. For example:

  1. In the UK, FEVR has 45% market share by value, 50% higher than Schweppes, 20x its nearest premium competitor and a 7x higher sell through rate than other premium mixers
  2. In the US, total points of distribution increased 33% yoy and August was a record month by number of cases sold.
  3. Europe is growing 30% yoy and contributes 33% to mixer category growth, >6x its nearest premium competitor
  4. FEVR is priced 2.5x Schweppes in the UK but has 45% market share. It’s rare that the highest price offering has such market share.

With such strong growth trends, the question turns to margins: is the gross margin pressure temporary or structural?

We recently interviewed a former Director of FEVR to understand the pressure on margins. This analysis aims to explore the evolution of FEVER’s gross margin and whether the company could return to the magical 50% / 305 gross and EBITDA margin structure.

Deconstructing COGS

Put simply, there are two line items in FEVR’s COGS: inventory costs (ingredients, glass, aluminium, packaging) and non-inventory costs (logistics and warehousing costs).

The chart below shows how gross margin has declined from 50.5% in 2019 to an estimated 34% in 2022. Over the same period, inventory costs as a percentage of revenue has increased 19% but non-inventory and warehousing costs have doubled.

Source: FEVR Filings, IPSource: FEVR Filings, IP

Between 2016-19, non-inventory costs as % of sales averaged ~7%. It’s estimated to be 17-18% in 2022. For the same period, inventory costs, of which 30% is driven by glass, averaged 40% and is expected to be 49% in 2022. Given opex as a percentage of sales is fairly stable and brand is strong, the recovery of gross margin is crucial for FEVR’s earnings power over the next 2-3 years.

A recap of the two recent guides by management provides helpful context to understand the gross margin outlook.

In March 22, management guided to a 450bps compression in FY22 gross margin due to higher inflation across its whole cost base including labour, sea freight, and uncertainty around Russia’s invasion of Ukraine. This was the slide presented to investors:

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