Over the last 6 months, Fever Tree has revised guidance twice: FY22 gross margins are now expected to be down 900bps year-on-year.
FEVR is seeing its lowest gross margins in history yet its brand seems to be as strong as ever: it has 45% UK market share and a 7x higher sell through rate than other premium mixers. In the US, total points of distribution increased 33% yoy and August was a record month by number of cases sold.
If the brand is firing, what needs to happen for margins to recover?
The two drivers of FEVR’s gross margin are inventory costs (glass, packaging, ingredients) and logistics and warehousing.
Between 2016-19, inventory costs as a % of sales averaged ~40%. Logistics and warehousing in COGS averaged ~7% of sales.
In FY22, inventory costs are estimated to be 49% and logistics 17% of sales.
Moreover, 60% of the logistics and non-inventory COGS is driven by the inefficiencies in the US supply chain. FEVR is currently shipping products from the UK to the US because it has struggled moving production onshore. With higher sea freight and US intra-logistic costs, this has led non-inventory costs to be 37% of sales in the US.
With these numbers, we can back out the US unit economics from the group:
FEVR's biggest market opportunity is heavily loss making.
But this is temporary.
FEVR believes they will have 80% of US production onshore by Q4. We believe solving the US logistics problem alone can improve gross margins ~500bps.
Current consensus doesn’t believe management can solve the short-term problems.
We walk through how FEVR’s margin could evolve and recap the company's long term advantage.
There is no doubt WSO is an incredible company with great historical returns. But one thing that we find curious about WSO is its Carrier relationship. To us, it seems to defy the core principles of the role of a value-added distributor.
My understanding of a B2B distributor, a huge part of the value is, basically, having a wide breadth of offering; saving the customer time in either sourcing product from many different OEMs, offering them scale advantages, in terms of price and time, and holding that inventory so they don’t have to hold it on their balance sheet. A wide breadth of offering, good price and selection, obviously, requires loads of different OEMs. From my understanding, I think 60% to 70% of Watsco’s revenue is from the Carrier relationship and it goes back to 2008, 2009 JV. From my work, most of the HVAC distributors, in the US, from OEMs’ demand, only hold one or two brands. For me, it’s odd to see a distributor being in the middle of the value chain and only offer their customers one or two brands. I couldn’t get my head around how much power does Carrier have? What are the risks with that? - WSO IP Dialogue
The HVAC industry is unique in that the distributors seem at the mercy of the OEM's. Each distributor exclusively carries 1 or 2 brands. Unlike POOL or FAST which both serve a fragmented customer base with thousands of products from a fragmented supply base.
WSO's relationship with Carrier seems effective and value-add for both parties today, but what if Carrier decide to take more margin? Or take some distribution in-house? It may be irrational but often we see new management teams make illogical strategic decisions to make their mark on an organisation.
WSO is effectively the monopoly aftermarket parts supplier for the largest HVAC brand. It's a great position to be in, but seemingly at the mercy of Carrier's demands.
Depending on where you live, you need heat and you need air conditioning. That bill can run up pretty high, especially if you are going on the higher end. We’ve only had it for a few months, but the energy savings, with the new models is significantly better. We’re saving hundreds of dollars a month in energy costs. That, to us, is the most likely reason that the replacement cycle that we would expect, based on historical trends – which would be pretty slow, especially after the big replacements in 2020, 2021 – they are going to need that SEER change to accelerate that replacement cycle. Otherwise, the next couple of years don’t look great from an organic standpoint.
This interview with an executive who led the build and rollout of SAP HANA 1.0 provides an inside perspective on how cloud infrastructure has evolved over the last two decades. It's worth reading in its entirety, although this answer to future hyperscaler market share really stood out:
It's always two [players]. It usually shakes out to be two. Snowflake and Databricks. There was Oracle and SAP. There's IBM and SAP. I'm just going with past history. - Former GCP Director
Can GCP catch Azure up?
It's really tough, and this is coming from an insider. We've been inside that echo chamber. They’ll do what they do with the ECU-Sandbox which was a much smaller version. They'll spin it out, and let it run as a separate company. - Former GCP Director
There it is. It seems like some GCP insiders hardly believe GCP will catch Azure. And in that case, maybe it will be spun out of Alphabet?
Although WINE has bigger issues to deal with, like organising it's board, liquidating inventory, and right-sizing it's cost base, there were a few encouraging data points on the core business model from our interview with Former Director of Naked Wines, Australia:
During the last six months I was there, we actively put every product from $8.99 minimum, and some went to $10.99, so there was an absolute increase in price, straight away. Every opportunity we had to increase a price, if something was a top seller or it moved quickly, prices went up. A year and a half ago, prices ramped up and they've increased that, plus they've also focused on taking on more top end product over that $15 price point. - Former Director, Naked Wines, Australia
In the last few years, the average price per bottle in Australia has increased significantly and the mix has shifted more premium. More interestingly, sales retention hasn't moved much.
This is impressive but the question is can WINE roll this playbook out in UK?
We discuss how WINE can replicate Australia's strategy and the potential challenges of the UK vs Aus market. This may be an opportunity, but first WINE needs to get its house in order and instil some confidence back in its shareholder base.
This document may not be reproduced, distributed, or transmitted in any form or by any means including resale of any part, unauthorised distribution to a third party or other electronic methods, without the prior written permission of IP 1 Ltd.
IP 1 Ltd, trading as In Practise (herein referred to as "IP") is a company registered in England and Wales and is not a registered investment advisor or broker-dealer, and is not licensed nor qualified to provide investment advice.
In Practise reserves all copyright, intellectual and other property rights in the Content. The information published in this transcript (“Content”) is for information purposes only and should not be used as the sole basis for making any investment decision. Information provided by IP is to be used as an educational tool and nothing in this Content shall be construed as an offer, recommendation or solicitation regarding any financial product, service or management of investments or securities.
© 2023 IP 1 Ltd. All rights reserved.
Subscribe to access hundreds of interviews and primary research