Fevertree Drinks PLC (FV8.SG) Earnings Call Transcript & Summary

Hello, and welcome to the Fever-Tree Pre-close Trading Update. My name is Courtney, and I'll be your coordinator for today's event. Please note that this call is being recorded. [Operator Instructions] And I will now hand you over to your host, Tim Warrillow, to begin today's conference. Thank you.

Thank you, and good morning, everyone. Thank you for joining us today. My name is Tim Warrillow, Co-Founder and CEO of Fever-Tree. And I'm joined on today's call by Andrew Branchflower, CFO; and Ann Hyams, Director, Investor Relations. So this morning, we published a trading update for 6 months of the year, ahead of releasing our half year results in September. As outlined in the announcement, we delivered a solid revenue performance in the first half of 2022, with a particularly strong performance in Europe. And whilst we're seeing positive top line growth and have maintained our revenue guidance for the full year, the challenging logistical and cost headwinds we highlighted previously was significantly worse in recent months, and we now expect this to continue to impact the business during the second half. I'll hand over to Andy, who will go into more detail on these challenges, how we expect them to impact our full year margins and the steps we are taking to mitigate those impacts.

Thank you, and good morning, everyone. So firstly, as Tim said, we delivered a solid revenue performance in the first half of 2022. We recognized some softness in our U.K. Off-Trade revenue but expect it to be partially offset by upside from our strong momentum in Europe. And as such, I reiterated our revenue range of GBP 355 million to GBP 365 million. However, clearly, this morning, we've updated our margin guidance, reflecting a significant worsening of recent months of logistical and cost headwinds, leading us to revise our outlook for the full year. The situation was materially changed with regards to 3 specific areas. Firstly, labor shortages slowing our East Coast production ramp-up. As a result, there will be greater reliance on U.K. production, and with it, more exposure to sea freight, where rates increased by up to 50% since the start of the year on key routes. That's on top of the significant increases we saw last year. Secondly, the availability of glass across the industry has become restricted, which has removed the opportunity to deliver upside to revenue despite strong demand. Thirdly, significant further inflationary cost increases and [indiscernible] which will impact the second half, most notably with regards to glass costs that we're also seeing this across our [ tax rate ]. So [indiscernible] a little more detail on this. The availability of glass across the industry has become restricted. Due to the strength of our relationships with our suppliers, we've been able to secure sufficient glass that led up against our revenue forecast. However, the opportunity for upside to those forecasts have been limited by the lack of availability of additional glass. As a result of this, we had no choice but to agree to significant double-digit cost increases from our glass providers for the remainder of the year. But there is the cost of being elevated, most notably with respect to gas. Glass is not the only source of inflationary increase. Across the supply chain, suppliers are struggling to cope with significant increases to their [ cost saves ] and are now [indiscernible] done. Whilst logistic costs remain elevated by fuel surcharges and inefficiencies as we're forced to work around delays and disruption. Alongside these cost pressures, our U.S. production ramp-up has been impacted on [ 3 fronts ]. On the [ workplace ], port congestion in the first half impacted our ability to deliver glass for the production site, which resulted in production delays and reduced inventory holdings. The congestion on the West Coast is finally subsiding, and we're confident of delivering our plant production asset on the West Coast in the second half of the year. Our East Coast bottom line has now been commissioned. However, the subsequent ramp-up to the required levels of monthly output has been impacted in the last few months by unexpected labor shortages in the market. With recruitment and retention extremely challenging, causing us to revise our expectations for the [indiscernible] to ramp up of the facility. The results of these challenges in the U.S., especially the delay in East Coast ramp up, is that we started from inventory shortages, which has meant we haven't been able to fulfill against the strong demand that exists in the U.S., particularly in June. We're correcting the inventory position by increasing U.K. production for the U.S., which will result in significant additional sea freight costs through the second half exacerbated by further underlying rate increases as well as additional internal [ breakups ], as we look to balance inventory between the East and West Coast over the coming months. The results of this exceptionally challenging operating environment, alongside the limited sales mix and FX hedging impact, is that we expect a further 450 to 500 basis points of margin dilution. And as such, expect gross margin in a range of 33% to 35% for the full year. This change in outlook for the year is extremely frustrating with a reflection of the changeability and challenges presented by the current environment, which we're navigating of the growth business, operating in multiple markets around the world. Whilst mainly we expected to be driven by the wider macro environment, we have taken steps to mitigate their ongoing impact while silencing the need to continue to strike the growth across our regions. We are looking very closely at pricing on a market-by-market basis. Whilst we do not expect to take price again this year, we made way through in-depth analysis surrounding potential improvements to 2023. In response to recent shifts in our glass availability, we're engaging proactively with our glass suppliers to secure 2023 volume decline, which should have [indiscernible] of costing as and when the underlying commodity pricing [ rebounces ] in the future. In the U.S., we have members of our team permanently on site at our East Coast [indiscernible] and are working with them on an action plan to recruit and train new sales members to allow us to ramp up outlook to the required levels over the remainder of the year, that will position us to benefit in 2023. We greatly reduced exposure to [indiscernible]. We are working on a range of projects, which include the onshoring of glass for our West Coast production facility and local [indiscernible] in Australia, which will further reduce our exposure to sea freight costs at [indiscernible]. Coupled with this, we're updating on our end-to-end operational processes and investing in new IT systems, which will allow us to scale and continue to improve our current capability, our procurement efficiency and [indiscernible] motivation, all of which will drive improvements in the bottom line. Consequently, despite the current challenges impacting gross margin, we remain confident in the long-term opportunity and we're continuing to invest in the brand and our capability to equip the business with a great opportunity ahead. We are planning the marketing spend at 10% of revenue and a building [ of booking ] to deliver against the large number of projects and progress across the organization, which will drive operational efficiency and cost savings over the coming year. As a result, we're increasing our guidance on operating expenditure to 23.5% of revenue, resulting in an EBITDA range of GBP 37.5 million, GBP 45 million for the year. I'll now hand back to Tim.

Thanks, Andy. I want to make it clear and remind everyone that despite the myriad of challenges across the business, we continue to make excellent progress across our regions, underpinned by strong and growing demand. And as such, we have more belief than ever for the future opportunity of the brand. However, to reiterate what Andy just outlined, whilst we are acutely focused on tackling the cost headwinds, many of these are transitory due to the proactive steps we've taken to ensure that we are not exposed in these issues in the medium to long term. The most significant of these is onshoring production in the U.S., Australia and [indiscernible] as we continue to grow. Of course, we recognize that certain inflationary impacts will remain, and we will continue to address them over time through pricing and economies of scale. But what we will absolutely not do is pull back investments in the brand or our people, and as a result, jeopardize the significant opportunity we have created. So thank you all for listening, and Andy and I are now happy to answer some of your questions.

[Operator Instructions] And our first question comes in from the line of Nicola Mallard calling from Investec.

A couple of questions from me, if I may. You mentioned some softness in U.K. retail, and I just wondered if you could give us a little bit more feeling as to why you think that's coming through? Is it early signs of recession, or is there something more specific? And secondly, around the glass issue, could you give us a bit of idea as to what exposure your glass costs are in terms of your total costs? And also, how easy do you think it will be to onboard glass in the U.S.? I mean, what sort of time frame should we be looking at for that? I mean, you say you've got enough for this year's production, but do we think it might limit next year's ability to drive the growth in the U.S. as well?

Nicola. So let me tackle your first question about U.K. retail. Look, I mean, clearly, there are lots of moving parts in there, and not least the return to the On-Trade. However, I think -- we think that are 3, I suppose -- many drivers. First, the early part of the year is impacted by Omicron which prevented people from -- and staying in their homes, which, of course, as you know, are doing so closely linked to it. Secondly, and probably most significantly, we're seeing very aggressive price promotional activity from other brands. And certainly, in the case of Schweppes, but also some of the small premium brands has been discounting very deeply. And whilst, of course, this will give them a short-term boost, we don't believe this is sustainable and it's not something that we have purposely being drawn into. So those really are the sort of 2 key factors. Also, we're seeing June [indiscernible] back really to sort of 2019 levels. That's sort of stabilizing. So those are, I think, the issues that had a bit of an impact. But make no mistake, in the U.K. Off-Trade, we're still in line with our 2019 levels. But looking ahead, looking to the second half, we're confident against delivering against our revised expectations. And partly, the 2019 comp that we track against is noticeably softer in the second half. But also we've got some new distribution coming through the sourcing. And whilst, as I mentioned, that gin is stabilizing, spirits in general, are strong and [indiscernible]. And as you well know, we've been diversifying our range to work with not just gin, but most of other spirits. And whilst as we always said that, that would take time for that country, we've really seen some very positive signs in ginger and soda ranges. And then the other aspect is that we've got very strong off-shelf promotional planning to Christmas, the sort of best ever, and we're also quite optimistic that this is going to be the first Christmas without restrictions since 2019. So we think as a result of all those things, we're going to be very well placed in the second half.

Yes, sorry. Could I just intervene on one quick question? Have you lost market share in U.K. retail? Because obviously, you've been holding fairly firm at sort of high 39s. Is that...

Yes. In the first half, Schweppes have gained a couple of percent. I mean, we're still ahead of the last Nielsen read, but their gain is really coming from winning from [indiscernible] because [indiscernible] has notably reduced their share, but we are still ahead. And then in the On-Trade, we have grown yet further ahead. So we're now well over 50% in terms of market share in On-Trade. But -- so the brand overall is still by far in the market in there.

Nic, picking up on your question on glass. And firstly, the proportion of our cost cut that relates to glass, well, in the context -- in the context of our glass business, the actual underlying glass is about 40% of the product cost. But obviously, in the context of our entire business, which includes canning and aluminum, it's about 30% of our total product cost. And then when we look at the kind of U.S. glass situation, we've onboarded glass on the East Coast of the U.S., and we've got good security and supply there to supply our East Coast production site locally. As I said, one of the challenges I see that we still have to import glass over to the West Coast. And in the first half, we've had severe port congestion on the West Coast of the U.S. It's been well reported, and the inability to get glass into the port has at times [indiscernible] our production line. Not only that, we also have to have significant increased freight costs to deliver that glass. So one of the key projects we're working on is ensuring glass for the West Coast in the U.S. We've got a number of options we're looking at. That's progressing well. We'd expect during next year to have that set up and coming online. So look, we're working harder there, and we're confident in being able to ensure, I'd say, by [indiscernible] glass during next year.

The next question comes in from the line of Ashton Olds calling from Berenberg.

Ashton here. First one, just on that -- it's been a 400 to 600 basis points. How do you break that down among the different cost buckets? So say, glass, freight rates and maybe mix impacts from the softer U.K.? I guess the second question, obviously, there's lots of moving parts. But what should we be expecting the gross margin trajectory to look like maybe next year? And yes, I guess maybe just in Europe, can you just pick some of those -- unpack some of the trends which are driving the strength here?

Ashton. Yes, of course. On gross margin, if we take the, I suppose, the midpoint of the movement we guided to today, it's 500 basis points. And the way it breaks down from our previous guidance is there's a 300-basis point movement related to effectively U.S. logistics. We previously, as expected, a 150-basis point tailwind from local production in the U.S. this year. We're anticipating over the fullness of the year costing about 60% of our requirements locally and 40% in the U.K. That's now flipping to sort of 40% locally in the U.S. and 60% in the U.K. Now on top of that, as I mentioned, the freight rates have increased significantly again, and so that's driving an underlying cost increase. And on top of that, as well as I mentioned, there's other costs that relate to this disruption, a significant element of which is internal freight costs. Because over next couple of months [indiscernible] having to balance inventory between the West and East Coast. But our 150-basis point tailwind has become 150-basis point headwinds and that slashes the 300 basis points there. If we then consider the rest of the bridge, the 500-basis point reduction, about 150 basis points is coming through from inflation. And look, we've spoken about glass. That's clearly a significant part of that, given the glass overall is 30% of our total product cost cut. But there's other elements as well. This is across the board. Sugar pricing is going to be increasing significantly in Q4, just to take one [indiscernible]. We are seeing that's across other suppliers as well. We're building in [ disagreed prudence ] in this guidance. And finally, there's 50 basis points, which is a better regional mix. The U.K. is coming off a little bit as we just talked about. And with it, we've got a little bit of a headwind on gross margin because of the way the regional mix is going to recalibrate. And we've got a very high FX set, which is all related to our hedging contracts unwinding and broadly seeing in the first half. That's how we bridged to that 500 basis points. Question is next year. And for the most part of today, we're working on a number of initiatives focused on driving agreements the way we are now. And no question, the biggest factor of that is going to be getting local production in the U.S. with [ locally-ensured ] glass operating effectively. And that's really where we're driving the second half of the year. We expect that to give us some significant upside. On top of that, as I mentioned, we're looking hard on price. We won't be taking price later this year, but we'll be looking at it on a region-by-region basis in early next year as well, and there's other factors as well. So we're confident we can drive improvement in gross margin at this point and I've got the last couple of months approved. The inflationary backdrop and the extent to which different elements of our cost curve are, particularly [indiscernible] in gas price increases, it's incredibly volatile [indiscernible] today. That's why we're holding our guidance for margin next year, but with more visibility on what that version backdrop is going to be like as we go in the second half of the year. As I say, from our segment, we're confident we sort of gain improvements that number I can show.

And then just to answer your question on Europe, there are a couple of key factors. But number one is really the strengthening of the brand. The investments that we have made over the last couple of years where others were pulling back, I think, is really paying dividends. The brand is better now, stronger, more widely distributed than ever in Europe. And so as a result, with this On-Trade returning, the brand is much more sort of front of mind. So we're really benefiting from that, particularly in the Southern European markets where the On-Trade is really balanced back. Italy, Spain, to name a couple. But also, that gin and tonic movement. So when we talk about the gin stabilizing in the U.K., gin is in [indiscernible] around the world, and is projected to continue to grow very strongly. And of course, the driver of this is gin and tonic. And so this is where we are seeing great excitement and opportunity in Europe. And then also, we're seeing some very interesting other market where gin continues to grow. So yes, we're delighted by the performance in Europe, and we're optimistic about the future of it.

The next question comes in from the line of Damian McNeela calling from Numis.

Damian here. Just in terms of -- I think you mentioned on the call that you sort of -- you didn't have sufficient product to meet demand at certain parts of the first half. Can you give us an indication of the sort of -- the kind of sales that you feel that you had to let go because you've not had the product? I don't know if you can sort of help us think about that. And also just on some -- can you give us a bit more sort of details on the initiatives that you're doing? And I think you mentioned the new IT system. Are there any costs associated with that, that we should be aware of?

Sure, Damian, yes. We spoke about 50 inventory shortages or restrictions and pinch points in the U.S. that particularly, I suppose, culminated in June, particularly. And so when we look at our U.S. business, year-to-date growth at the end of May was 20%. And then we had a shortfall in June relative to demand. So I think we're very confident that the underlying growth as represented by the demand we're seeing in that U.S. market is greater than the 11% reporting in the first half. We're also confident in the fact that we're going pique July and catch up on that shortfall in June. And as I said, we've taken these steps to ensure the inventory bills over the coming months, and with that, unfortunately, additional costs. But we're not moving our U.S. guidance range. We're very comfortable with our ability to hit that. And there's no question, the underlying demand in the U.S. is extremely strong. The second question in terms of the projects we're working on. There are a number of different areas. But yes, look, specifically in relation to our sort of IT projects [ thus close ]. And first and foremost, we're really overhauling and rebuilding our inside operational processes throughout the business. So -- and with that, within -- adding to that with operated improved IT systems, particularly around the supply chain planning, and it does require significant investment. It was built into our original guidance, and we are also taking on some additional heads to make sure we can deliver that in a timely manner because we see the benefits that it's going to drive. And -- but yes, we're very focused on making sure, a, we can mitigate the kind of headwinds we're seeing. But also fundamentally to be prepared for the great opportunity here and be able to scale this business as it comes true in coming years.

The next question comes from the line of Fintan Ryan calling from JPMorgan.

A few questions for me, please. Firstly, you said that the -- given the costs headwind that you'd be considering price actions from -- into 2023, a number of companies in Europe have been starting to talk to kind of go for incremental pricing during this year. Just wondering why maybe you're holding off in taking some of the pricing to offset the headwinds. And then just with regards to the U.S. pricing specifically, do you feel that you don't have the pricing power to take the pressures that you're facing currently? Or how should we think around the -- you really need to take price in the premium mix segment in the U.S. market vis-a-vis peers like Q Tonic?

Yes. Look, let me answer that. I mean, just to be clear. Here in the U.K., we have taken price this year. We've taken 8% price, so a very noticeable price increase. And as Andy mentioned, we are then looking hard at the merits of taking price again next year. And with regards to the U.S., make no mistake, we really do have pricing power because we're already sitting at twice the price and more of our major competitors in Schweppes and Canada Dry. And despite that very high price point as we are discussing, demand is very strong for the part. So that is a reflection of the pricing power we have. But what we don't want to do is just pass price through and destabilize this fantastic momentum and growth that we're seeing and rate of sale [indiscernible] the brand. And that is what is allowing us to win new distribution, which we're optimistic is going to keep coming our way. And that's, I think, no greater escape than undermining that momentum at this point in such an exciting and significant market and opportunity for the brand. So we will look absolutely in the U.S. next year at the merits of it, but we're not sitting and saying that we are absolutely [indiscernible] price at this point.

Great. And just the second question, just with regards to the full year guidance in terms of revenues. You've kept the high-level numbers unchanged. I think you said as well that the U.S., at least where the GDP standpoint is going to be unchanged. But how should we think around the U.K., your expectations for U.K., Europe and rest of world in terms of revenue outlook?

[indiscernible] Just regionally.

Sorry, we're just breaking up a little bit and we're coming through.

But broadly speaking, I think when we think about our guidance range and how we positioned it in March, where we see, as we say, some softness in the U.K. And so that -- we would expect that to come down by broadly GBP 5 million from our original kind of range, but then we see that being offset predominantly in Europe. But you can see from that first half, fantastic momentum we've got, which is great on a very, very strong first half last year where we've got confidence of upside opportunity, particularly in that region.

The next question comes in from the line of Doriana Russo calling from HSBC.

I've got a couple of questions. The first one is really -- I'm trying to understand at what point in time did you started to realize that you did not have enough production to fill demand in the U.S.? And you said that you expect to be able to offset some of the shortfall in June -- in July, how you're going to do that exactly? And what's the likelihood of further sort of disruption that we may see in the second half with regard to the U.S.? The second question is really in terms of exposure to Europe and what sort of consequences, if any, you could have with regard to the shortages of gas in Germany and the neighboring countries? And finally, your exposure to the U.S. dollar, is that fully hedged? Or are you possibly going to benefit from a much stronger dollar as in the latest period that we are observing?

Sure. So Doriana, in terms of the U.S. picture, as you said, there's been a number of factors that have been impacting, obviously, our inventory levels. Whether it's port congestion, whether it's this slower ramp-up than expected on the East Coast and still, frankly, the unpredictability of lead times on transatlantic freight. Because then together, we all anticipated making significant amounts of products still in the first half of this year and shipment to the U.S. was more in the second half where we anticipate that East Coast production line hitting up the baton. And look, these things interact and overlap and for consideration in June, for instance, we had 2 factors. One, our East Coast production wasn't at required levels of [indiscernible]. Secondly, we frankly had a huge amount of product sitting outside the port in New Jersey waiting to be -- waiting to sort of dock and be deloaded. And that's happened now in the last couple of weeks. There's a huge influx of inventory, which is why we're confident we can replenish in July. But the decision we've made recently is to derisk this ramp-up on the East Coast. We will be working fairly hard with bottlers to ensure that they do ramp up quickly now as we progress through the year, but we've taken the decision to increase U.K. production, derisk that. And so we see inventory building now over the next couple of months, getting back to a very strong position. And then certainly, as we get into the key holiday season in the U.S., we are predicting, and we are forecasting to have good levels of inventory that should ultimately offset and derisk the likelihood of any further disruption. On Europe, look, you're highlighting one of the areas of unpredictability we're all in, we're currently across multiple different industries. We have a network of 3 different bottlers in Europe, and of course, we have 2 in the U.K. as well. So if there are pinch points, for instance, in Germany on gas, we'd be able to shift production around our network. And that illustrates the kind of environment our supply chain teams are dealing with and having to constantly work on that. So we think we've got a redundancy in our European production [indiscernible] line. On the dollar FX question, yes, look, there's been FX upside of space this year in terms of the movement in the exchange rate. We were well naturally hedged with the U.S., and now these incremental costs, particularly these transatlantic freight costs, on that natural hedge has improved more to the extent that further FX upside doesn't have any effect on gross margin. We just -- it kind of washes through. But where we've actually got a slight headwind is the fact that our hedging contracts were placed before our natural hedge increased, if you like. So the contracts were placed in order to bridge the gap with the natural hedge we had in our exposure and now, given that, that [indiscernible] has increased, the contracts that have crystallized in recent months beginning a slight headwind. So from a margin perspective, there's no upside from the U.S. strengthening this year. When we reported revenue perspective, there is some of that upside in that.

That was the final question in the queue. And with that, that does conclude today's conference. Thank you for joining. You may now disconnect your handsets. Host, please remain connected and await further instruction.

Thank you.