Stock in Focus: Fever-Tree loses fizz but Finsbury Food looks sweet

Commiserations to Fevertree Drinks (LON:FEVR) shareholders, who started the week with a profit warning and a 20% drop. 

From what I can see, this business is at a fork in the road. The core UK market is now mature, and probably saturated. There’s a lot more competition than there was five years ago. 

Founder and CEO Tim Warrillow believes he can replicate the group’s UK success in the much larger US market. He’s planning to ramp up spending and take a hit to profit margins in 2020, in the hope that Fever-Tree can “unlock the wider potential of this very significant market”.

Will Mr Warrillow succeed? I find it hard to form judgements about highly-rated growth stocks, which is why I rarely buy them. Stockopedia classes Fever-Tree as a Falling Star, a view I’d share. But if the group retains its ability to generate a 30%+ return on capital, then the newly reduced share price could prove a good entry point. It’s your call.

A more affordable option?

I tend to shop for stocks at more modest price points. Indeed, my rules-based SIF folio (this link will only work on the old Stockopedia site) is designed to identify stocks offering affordable growth. 

The company I’m going to look at this week is pretty much the opposite of Fever-Tree. Finsbury Food (LON: FIF) is a small cap bakery firm that produces bread and cakes for the retail and foodservice sectors. It also produces cakes under a number of licensed brands, including Thorntons, Disney, Mary Berry and Baileys.

To be honest, it’s a bit dull compared to Fever-Tree. But I quite like boring stocks. Stockopedia’s algorithms like Finsbury too, awarding it Super Stock status. Indeed, this £125m business is the second-highest ranked share in the Consumer Defensives sector, behind another not-so-exciting stock, British American Tobacco:

In contrast, Fever-Tree languishes closer to the bottom of this sector, with a StockRank of 34. Statistically, companies with high StockRanks have outperformed those with lower ranks in recent years. 

Finsbury released a fairly positive half-year trading update last week. This stock would also add some much-needed defensive exposure to my SIF portfolio:

I’m keen to find out more. Is there anything to like (or dislike) about this business?

Value: promising

This is a relatively low margin and capital intensive business that’s been built up through a string of acquisitions over the last 17 years. There are risks with such a model, so to invest I’d want to see evidence of reliable cash flow, a modest valuation and low levels of debt. 

Does Finsbury Food meet these requirements? Here’s how this stock scores for value:

The earnings yield (EBIT/EV) of 9.4% is a big attraction for me and suggests that the business is valued attractively relative to its earning power. The P/E and dividend yield also look reasonable to me. 

However, the price/free cash flow ratio of 50.1 is clearly something we need to understand a little better. Let’s start with a look at Stockopedia’s cash flow history for the stock:

We can see that operating cash flow has weakened each year since 2016, while capital expenditure has remained fairly stable. As a result, free cash flow has fallen significantly. To find out more, I’ve taken a look at the company’s accounts.

My impression is that the last few years have been a time of transition. In 2018 and 2019, for example, Finsbury recorded cash outflows totalling about £8m on bakery closures and acquisitions. There have been some big shifts in working capital, too. The situation appears to be summed up by this CEO comment from the FY19 results:

Stripping out all these factors, my impression is that operating cash generation has been fairly stable. So I’m willing to give the firm the benefit of the doubt at this time.

One final note regarding debt. Finsbury Food’s net debt rose from £15.6m to £35.6m last year, mainly as a result of the £16.9m acquisition of Ultrapharm. This equates to leverage of 1.4x EBITDA, which looks acceptable. 

It’s also worth noting that the group had a year-end client debtor book worth £45.2m, mainly due to “large multiple retailers” — mostly supermarkets, I’d guess. Although this highlights the tough payment terms demanded of the firm by its customers, I think it should also be fairly low risk. To some extent, we could argue that this offsets the group’s own borrowings.

I’d expect to see net debt fall this year, but on balance I’m comfortable with the current situation.

Quality: better than you might expect

Finsbury Food scores highly for quality, with a QualityRank of 87:

If your idea of quality is based on high margins and high ROCE, you may be surprised by this score. Finsbury’s long-term average return on capital of 9.2% is fairly average and its margins are low. 

Despite this, the group’s assets appear to be reasonably profitable and cash generative (circled). A Piotroski fundamental health score of 6/9 also indicates good cash generation and improving performance.

The StockRanks seem to suggest that this business is on an improving performance trend. I’d tend to agree, assuming management resist the temptation to make any more acquisitions.

Momentum: further upside?

Does Finsbury Food’s momentum score support the argument that the outlook is improving? Perhaps. A score of 80/100 is encouraging, in my view:

Price momentum has certainly been strong recently – the shares have risen by about 40% over the last six months.

Earnings are expected to rise by about 25% this year and then more modestly the following year (the current financial year ends in June):

Despite Finsbury’s rising share price, its valuation remains quite modest. 

Looking ahead, the stock trades on less than 10 times forecast earnings, with a prospective yield of 3.9%. As Graham Neary commented last year, this isn’t a stock that deserves a high valuation. But if the company can continue to deliver what it has promised, I think there’s some scope for further upside.

My decision

I’m tempted by Finsbury’s defensive qualities and the potential for improving performance. I don’t think there are any red flags to deter potential buyers and I’m also impressed by how highly the shares are rated by Stockopedia’s algorithms.

I’m going to add Finsbury Food to the SIF folio and to my own holdings this week. As usual, I’ll make both purchases after this article has been published. I’ll then hold the shares for nine months before reviewing the holding once more.

Would you opt for Fever-Tree’s valuable brand and growth potential, or are you happy to look for incremental gains with Finsbury? I’d love to hear your views on these two very different businesses in the comments below.

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