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Investor Dialogue: Fever Tree

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Fever Tree US vs UK Growth Opportunities

At In Practise we have a coverage list of 350+ quality companies that we want to study, and we spend a good amount of time debating internally which companies to prioritise next.

The potential duration of sustainable growth is a top variable we consider when making such a decision. Beyond the obvious benefits, the duration of growth is important because it gives us the best chance to compound our knowledge.

We want to build company-specific knowledge today that we can build on for decades. We also want to get to know founders and management teams that will still be playing their game many years from now. By spending time on companies with long durable growth opportunities, we give ourselves the best chance to compound company and industry-specific knowledge. Years of watching how companies and managers behave can also help build conviction in future challenging times.

A quote from a recent interview with Gavin Baker of Atreides Management reminded us of this point:

“Everybody looks up to Warren Buffett, but almost no one does what he says he does. Warren Buffett has said he doesn't do due diligence. This was a statement about Precision Castparts which is one of his largest acquisitions ever. And everybody just ignored that comment, but it was a profound comment. And what he meant by it was that he didn't need to do due diligence. He had been reading every 10-K published by Precision Castparts for decades. He didn't sit down and do some 60-day deep dive. He didn't need to because he had been doing due diligence on Precision Castparts for decades”

We believe Fever Tree (FEVR) has the potential to grow for decades and so is worth taking the time to understand.

We recently held an In Practise Investor Dialogue with two Fever Tree shareholders to explore the investment thesis and the company’s growth opportunities.

When looking at the potential duration of FEVR’s growth, one investor asked the following question:

"I wonder, did they just enjoy a huge first mover advantage in the UK and, to a lesser extent, they’re enjoying it in other countries in Europe and the US? Or is there something else which will allow them, even if they come late to other markets, to actually capture those markets?"

FEVR has ~50% market share in the UK mixer category and the company is growing low-mid single digits per year. Thus the FEVR investment thesis is based on growth outside of the UK.

So why wouldn't Fever Tree grow in the US or Europe as it did in the UK?

Fever Tree, born in the UK, pioneered the premium mixer category which now accounts for 43% of the total mixer category by value. FEVR’s growth was predominantly driven by the growth in the gin category; the number of UK gin distilleries has doubled over the last 5 years and consumption is expected to increase to over 10m cases in 2023, nearly double the consumption in 2010. Some investors worry that FEVR is too reliant on the classic gin and tonic. However, this comment by the company’s co founder and CEO in the last earnings call shares a different perspective:

“We've got this fantastic position in the world of Gin & Tonic, where all the spirit partners wanted to push and promote our brand alongside theirs, but so are the spirit partners now in these other spirit categories that we're developing these products for. So the vodka category is big in the U.K., and the vodka categories looked on in great envy at the way gin has been able to premiumize. So they are keen to work with us to help develop that.”

The premiumisation of gin in the UK has been so successful that other spirit categories wish to follow the gin playbook. This suggests Fever Tree has a larger UK opportunity than the 3-4% revenue growth that analysts currently forecast. We believe the premiumisation of spirits is a global structural trend that will continue to penetrate all categories globally.

Although the UK may continue to grow mid-single digits, Americans consume ~450m litres of spirits per year, 10x the volume in the UK. This makes the US market crucial to Fever Tree’s growth. There are two key questions when comparing the US opportunity to the historical success in the UK:

1. Can the US premium mixer category reach the UK’s level

2. Can Fever Tree capture a similar market share in the US as in the UK

The US premium mixer category is only 10% today compared to 43% in the UK and 18% in Europe. This is partly because US spirits consumption habits are different to the UK. Firstly, Americans drink more darker spirits which have strong mixers dominated by Coca Cola and numerous ginger beer brands. Bars and restaurants also predominantly use the soda gun for mixers which are less prevalent in the UK.

This has led FEVR to launch products that are less focused on white spirits and more on mules, ginger ales, and spritzers. The success of FEVR’s ginger ale and the new grapefruit seltzer proves that Fever Tree is far more than just a tonic brand and is capable of driving the premiumisation of mixer categories outside of tonic. This was Charles Gibb, FEVR US CEO, in the last earnings call:

“Innovating and creating new exciting products is one of the cornerstones of the brand. So I thought it was worth taking you through our journey to create the Sparkling Pink Grapefruit, which we launched in March 2020 during the worst of the pandemic. It quickly became our most successful new product launch in the U.S., getting significant attention from retailers and consumers and now making a significant contribution to our sales growth. Sparkling Pink Grapefruit was crafted to pair with tequila for the perfect lower-calorie Paloma, leveraging the exceptional growth and premiumization of the spirit category. Just over a year after we first launched it, we're already driving over 20% of grapefruit category growth through the elevation of mixing occasions in both tequila and vodka.”

The ability of FEVR management to create new products and the flexibility of the Fever Tree brand seems under-appreciated by the market. The US business is FEVR’s fastest growing region and management believe they can 5x the business in the medium term with the vast majority being non-tonic lines.

But even if premium mixer penetration reaches UK levels, why would Fever Tree capture the largest share of the market?

It seems FEVR gained share in the UK because they had a better tasting product than Schweppes and deep partnerships with premium spirits companies. This built the allure of a premium brand in the consumer’s mind while Schweppes’ convoluted ownership structure made them slow to react. The UK’s relative lack of soda guns and the visibility of the brand during the typical on-premise consumption experience meant FEVR’s UK growth was rapid, leading the company to win over 40% market share in a decade.

The US market is very different today compared to the UK 15 years ago: Schweppes has woken up, Q-Mixers has well-established off-premise distribution, and the US grocery chains are also rolling out private label mixers. However, in the US, Fever Tree is following the same go-to-market approach as in the UK; building brand equity on-premise to translate into off-premise volume. This is what we wrote in a previous In Practise Weekly Analysis:

"Fever’s off-premise strategy relates back to the core DNA of the company. Charles Rolls, Fever’s cofounder, is a former gin distiller and the current US CEO is the Former CEO of Belvedere, LVMH’s leading vodka brand. Premium spirits are at the heart of Fever’s philosophy. Driving consumer awareness and discovery is the biggest challenge for any new consumer brand and the company is relying on on-premise exposure and experimentation to translate into off-premise growth."

Fever Tree is run by liquor people and partners with liquor brands. The company is organized to sell through its national distributor Southern Glazer’s whereas Q-Mixer’s and Keurig Dr Pepper are built more with direct sales teams focused on off-premise distribution.

Is there a possibility that creating a brand on-premise doesn’t translate to significant off-premise volume in the US? This is what one investor thought:

"Of course, they need to focus on both channels but I personally think building the brand better, with more focus initially in on-prem, is the right thing to do. I don’t see why there would be two brands long term, with one brand winning on-prem and the other off-prem. Certainly, owning on-prem is harder and takes longer but I think it’s the right thing to do because, in my view, that builds a far more sustainable brand."

There may well be a strong connection between on-premise and off-premise brand equity, but the presence of Q-Mixers and Keurig’s power in the grocery chains could make US growth slower than the UK.

Also, could Fever Tree’s on-prem focus limit the off-premise distribution only to points of sale with licenses to sell liquor? Although the majority of volume will flow through the large retailers, the majority of US retail stores don’t have a liquor license. It may not be crucial for the company to win distribution in the convenience channel for FEVR to be a good investment today, but it could be a challenge in the long run. All of these factors combined could make the US growth story more difficult than the UK.

Fever Tree also has a large growth opportunity outside the US; the company currently earns ~27% of revenue from Europe which is growing at 20%+ per year. The Big Soda companies have less power throughout Europe relative to the US and, although Schweppes is a clear market leader, distribution is far more fragmented. This was one investors’ comment on the competition in Spain:

"In Spain, for example, where gin and tonic is huge, they struggle to gain decent market share. I think it is the country in Europe where they have struggled most. I think that’s because gin and tonic is so large, Schweppes had a lot to lose. They reacted fast, they launched their own premium tonic and, in reality, my feeling is that final customers don’t care that much about the difference between Fever-Tree and Schweppes Premium tonic. They do care versus the standard tonic which, by the way, the liquid itself is exactly the same; it is just the bottling that changes in Schweppes in Spain and they have retained very strong market share there."

It’s encouraging for FEVR that Schweppes is supposedly using the same liquid in both the Premium and basic tonic water products:

"What you are saying about Schweppes is somewhat optimistic because you can’t fool customers forever. It is not a good way to maintain your integrity. Schweppes is a challenge as it is, because they are owned by five different companies or entities, across different geographies. It is not as if there is a cohesive effort to attack the high end. "

Fever Tree’s growth proves that the fact Coca Cola, Keurig, and Suntory all share ownership of Schweppes across different regions makes it very difficult to launch a cohesive global response. This makes FEVR the only global, premium mixer brand today.

This comment from an investor was also interesting:

"Look at what Monster did with Coke. I don’t remember the deal but they gave 15% of the company to Coca-Cola and the stock went up 40% on the day and, since then, it’s been one of the best performers on the US market because the growth that Coca-Cola was able to give them by putting them through the distribution channel was unbelievable. Again, distribution in this market, for both spirits and mixers, is very tough and it is especially tough to go it alone like Fever-Tree is doing in some markets, with no portfolio of products."

We’ve always wondered why Diageo doesn’t own Fever Tree? Maybe FEVR wants to be spirit brand agnostic but Diageo or Pernod’s portfolio is wide enough to serve most categories. A similar deal to Coke / Monster could be possible for Fever Tree. The strategic value of Fever Tree within the spirits industry could also put a floor on the company’s valuation.

As with most long duration stocks, FEVR is by no means cheap and trades at 58x analysts’ 2022 estimates of FCF. In the long run, the company has guided towards a 50% / 30% mix of gross and EBITDA margin. Management guided to ~200bps unwinding of higher cost of goods from logistics and shipping product from the UK to the US market; this should improve gross margins towards 47-48% over the next 3 years.

By our 2025 numbers, we believe FEVR can earn ~£170m EBITDA and over £115m FCF with revenue still growing double digits. It’s not cheap, but a global premium brand with such a growth runway deserves a premium in today’s market. We plan to explore the US off-premise channel in more detail in 2022.