Investor Dialogue: Fever Tree | In Practise

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Investor Dialogue: Fever Tree

Why is this interview interesting?

Investor Dialogues is a new format at In Practise. We invite 3-5 professional investors from our audience to participate in a recorded discussion on a specific company. Each participant is anonymised and named analyst 1-X in the transcript.

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Fever Tree

Why is this company interesting?

Fever Tree is a founder-led beverage business that sells premium mixers such as tonics, ginger ale, and club soda.

Over the last decade, two tailwinds have fuelled FEVR's ~50% revenue CAGR: premiumisation and spirits winning share from beer and wine. The company defined the UK premium mixer category which accounted for 43% of all mixers in H121. In the US, the premium segment is only 10% but is growing at ~3x the total mixer market.

In 2018, the company launched a national distribution agreement with Southern Glazers, the largest spirits distributor in the US. Fever Tree focused on building the brand equity with premium spirits companies in the on-premise channel and has the longest and deepest relationships with companies like Diageo and Pernod.

Fever Tree is a beverage company that operates closer to a premium spirits business with 30%+ ROE, deep distribution agreements and high brand equity in both channels that provide high barriers to entry for competitors.

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Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

I guess a good place to start is the total potential opportunity for Fever-Tree, in the long run, given where it stands today and the growth in the US and globally, £252 million revenue, last year; guided £300 million this year. How do you look at the long-run opportunity for Fever-Tree revenue growth?

Analyst 1: I think there are two fundamental questions that are essential to answer and you have to come at them a little differently. Firstly, can the US get to the same level of penetration of premium mixers as the UK, in aggregate? If so, how long is it going to take to get there? They don’t need to get there for the stock to work, but I think that is one of the big questions we have all got to figure out. Secondly, looking at the rest of the world, as they achieve more of their ambition in the US, can they turn their sights and get to some of these other regions where spirits have taken good share in general and high-end, in particular, has an opportunity? The rest of the world is really pretty small but, at some point, that could be as big an opportunity as the US alone.

When I look at this, I try to think about what the true duration is of the high-growth period in this company? For how many years can they truly grow at double digits? If it’s more than a decade, this thing is a pretty damn good investment. If it’s going to be less than that, not so much.

What could be the reasons why the US doesn’t get to that similar penetration for premium?

Analyst 1: I think there are a few that I try to think about, with respect to success in the UK and what they are doing here. Firstly, we just don’t drink gin the same way. Secondly, the spirits that the US drinks a lot of, pair already pretty naturally and pretty well with some very prolific companies that are out there, such as Coca-Cola. Rum and Coke; that is the name of a drink. Cola, in general, pairs well with the darker spirits and that’s harder for anyone to attack. If you look at the more natural ingredient colas that are just trying to get into the mainstream market, they’re tiny; they are like a pimple on the market. I think that’s a challenge. It’s a different type of drink and it requires a different kind of flavor balance.

Then the other challenge is – and it’s one of the questions I really struggle with – there is more competition in the US. There is also more inclination, in the US, to invest aggressively when the opportunity is large. Culturally, Fever-Tree is very disciplined and operating with that kind of discipline maybe to their detriment here. They might be better off marketing really aggressively, whilst the opportunity is wide open and doing more to preclude competition.

Those are the two things I really wonder about, in the US.

Analyst 2: I fully agree. To understand the potential in other markets, outside of the UK, you need to understand how big those drinks themselves – gin and tonic, Moscow mule and so on – can be in other markets. In the UK, I think Fever-Tree benefited massively from the explosion in gin and tonic but I don’t think we can expect something similar from the US. I certainly wouldn’t expect them to displace Coca-Cola, which is just too relevant.

For example, in Germany, I understand that gin and tonic is gaining some market share and that, of course, is helping Fever-Tree. Their mixers are so focused on those two drinks, you actually need the mixers themselves to grow.

Analyst 1: You raise an interesting one with the mule, because that is a pretty popular drink nowadays, and it’s also pretty versatile. You can have it with tequila or you can have it with whisky; let alone vodka, which is the traditional one. Ginger ale intrigues me, in general, because they have a good offering; it captures the zeitgeist of being lower calorie and natural ingredients. 80% of ginger ale is consumed separately from alcohol companionship. That’s the big opportunity. If you could get a wedge in and get people to buy into your product – ginger ale, ginger beer, whatever it may be – the ginger is just far more popular.

The one stat that I found that really piqued my interest, when looking at this question of how big this can get, is the relative market sizes of spirits in the UK versus the US. I think it is roughly 40 million liters of premium spirits in the UK but almost double millions of liters in mixers which is roughly 40% premium mixer penetration. In the US, there are 450 million or 460 million liters of spirits and 40m premium mixer liters, so only 10% premium mixer penetration. I wonder if there is any reason why the US premium mixer volume couldn’t reach UK levels?

Analyst 2: Has it happened in the UK, that people are drinking these premium mixers, without alcohol?

I think part of the volume is being consumed as an alternative option.

Analyst 2: That’s interesting. I do believe, for now, the near-term opportunity is for mixing with alcohol and that is what allows you to build the premium brand. It is such an emotional consumption, when you drink with alcohol, that people are actually willing to pay more for it. Could they expand beyond that? Probably, but I don’t think we need to see that to get decent growth.

Analyst 1: It’s something that I struggle with because they explicitly say that they’re not going to try to push that. But I do think it totally happens and it’s a little more natural in the US because tonic itself doesn’t lend itself well to downing a bottle with lunch. But ginger ale absolutely does; cola absolutely does. Their grapefruit spritzer was, I think, called the best launch they ever had in the US. Something like that, which is 30 calories, but flavorful, is pretty appealing but it’s also way more competitive.

You don’t actually want to attack that market because then you are competing with all kinds of flavored seltzers and Coca-Cola. I do think that it’s better to focus narrow but to at least try to win some favor, win some appeal, with people who might be warm in introducing the brand to other people.

I wonder if, in the US, they are being a little too tepid in their fervor for hitting the market. They should be getting influencers. They compete with Q Mixers here, who have changed their name three times in the last five years and yet still, they’ve forged themselves a pretty good presence. They’ve been way more willing to work with influencers, to spend marketing and to try to build a brand, where Fever-Tree is, I think, building customer relationships. They are taking different tactics on that.

It also seems to me, over the last couple of years, that they just didn’t have the inventory, storage and logistics available to even meet the demand they could generate. I think, in Q2, they plan to have East and West bottling ready in the US. Hopefully, towards the end of next year, we should see some bigger TV ads and marketing, to ramp demand.

Analyst 1: I think that will be one of the foremost signals that they are actually achieving their US ambitions, when they flip the switch and actually start brand development, brand marketing.

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