The FTSE 100 may be notching up new record highs, but many smaller UK stocks continue to languish. So I reckon there could be some lucrative opportunities further down the market.
One share that I’ve had my eye on for a while is Fevertree Drinks (LSE: FEVR). Shares of the premium mixers firm have plunged 62% in five years and 20% over the last 12 months.
According to analysts at Deutsche Bank though, the stock has the potential to rise 38% from here.
Not being fully captured
In a research note published one week ago (30 April), the bank’s analysts initiated coverage on the growth stock with a ‘buy’ rating.
They put a 1,600p share price target on it, which is around 38% higher than it currently trades at (1,150p).
The bank said: “We believe in the long-term premiumisation opportunity and think Fevertree is well positioned given its first-mover advantage, strong brand credentials, high-quality products and capital-light business model.”
The analysts recognised that the last couple of years have been challenging, with the company’s profit margins coming under severe pressure due to inflation.
However, the bank added: “We also believe in the longer-term revenue potential of global mixer premiumisation. We do not think [this is] being fully captured in the current share price.”
More art than science
Now, I generally take analysts’ share price targets with a grain of salt. Deutsche’s 1,600p target (the maximum current estimate) is more than double the minimum estimate of 700p set by another bank.
That’s a very wide difference, which goes to show that assessing the prospects for individual stocks can often be more art than science.
Margin recovery potential
Part of Fevertree’s premium brand image lies in its glass bottles. So when soaring energy prices impacted glass production costs, as well as shipping rates, the company’s profits came under massive pressure.
2018
2023
Revenue
£237m
£364m
Operating profit
£75.4m
£20.8m
Operating margin
31.8%
5.7%
Basically, Deutsche Bank’s bullishness lies in recovering margins. It believes we’ll see a strong margin recovery this year and over the medium term. It doesn’t believe the collapse is “structural”.
In its 2023 annual report, Fevertree noted that it had a new glass contract with fully hedged energy pricing for 2024. Plus, transatlantic freight rates have stabilised.
Management expects these things to support margin improvement.
Mixed feelings
Looking ahead, there is a shift towards consumers drinking more spirits rather than beer and wine, with a growing preference for premium brands. This simultaneous trend should play into Fevertree’s hands long term.
In 2024, revenue is forecast to grow around 8% to £393m. I’m encouraged that the firm is still expected to grow and take market share, despite challenging economic conditions.
Meanwhile, the US is now the firm’s largest revenue-generating region. When so many UK consumer brands fail across the pond, I find this a notable achievement.
North America is a very large potential growth market for Fevertree over the long term.
However, one issue I have here is valuation. The stock is trading at 37.6 times forecast earnings for 2024. There doesn’t appear to be much margin of safety at that multiple, in my opinion.
So, I’m keeping the stock on my watchlist. I love Fevertree’s brand and its drinks, especially the Mexican lime soda. But I’d like a cheaper valuation before investing.
The post This unloved UK stock could rise 38%, according to a City broker appeared first on The Motley Fool UK.
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Ben McPoland has no position in any of the shares mentioned. The Motley Fool UK has recommended Fevertree Drinks Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
