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A tale of two margins: How the UK’s sugar tax affected Fevertree and AG Barr

The levy, which came into effect on 5 April 2018, aimed to cut down on childhood obesity rates in the UK by upping the price on drinks with high sugar content

Fevertree drinks
The levy helped cut posh tonic maker Fevertree's margins by 170 basis points in 2018

Looking at the final results of AIM 100 fizzy drinks maker Fevertree Drinks PLC (LON:FEVR) and its FTSE 250 rival AG Barr PLC (LON:BAG) on Tuesday, the figures provide a reflection on how preparing for the UK’s sugar tax paid off for one and a lack thereof caused the other to suffer.

The levy, which came into effect on 5 April 2018, aims to cut down on childhood obesity rates in the UK by upping the price on drinks with high sugar content (with the added bonus of netting a tidy £240mln each year for the Treasury).

The rates are 24p per litre of drink that contained 8 grams of sugar per 100ml, and 18p per litre containing 5-8 grams per 100ml.

Tax makes Fever go flat

Posh tonic maker Fevertree, which also sells fancy ginger beers, lemonades and a Madagascan cola, suffered some hefty damage from the sugar tax.

The levy piled pressure on the company’s gross margins in 2018, which shrank to 51.8% from 53.5% the year before, a drop of 170 basis points.

The hefty cut to its margins overshadowed what seemed by other metrics to be a strong year, with revenue up 40% in 2018 to £237.4mln and a hike in the final dividend to 10.28p per share from 7.64p in 2017.

Given that the firm’s standard tonic water has about 7.1g of sugar per 100ml, its cola around 9g, and its ginger beer 9.2g, a large segment of its product range is still in the firing line for the 24p per litre price increase.

READ: Fevertree falls flat as UK sugar tax and surging bottle costs dent margins

As the UK is also Fevertree’s largest market, the margin pain looks set to continue unless it can diversify its sales away from the tax.

Although with its US business struggling to grow sales, this could take longer than initially thought.

“The problem is that demand for premium tonics hasn’t yet caught on across the pond, so the group is relying on the sale of its ginger ales. The market place for these kinds of mixers is crowded, so it will be harder to replicate the stratospheric increase in demand for tonic we saw in the UK,” said Sophie Lund-Yates, equity analyst at Hargreaves Lansdown.

Given its stratospheric rise to prominence over the last three years, with shares up over 300%, the tax man seems to have added a bittersweet taste to Fevertree’s success.

Barr fizzed on new formula

By contrast, AG Barr reacted relatively swiftly to the new levy before its implementation by reformulating the recipe for Irn-Bru, its flagship soft drink, in January 2018.

While news of the changing formula was accompanied by some punters stockpiling the unchanged recipe to preserve the “original” taste, the new formula brought Irn-Bru down to less than 5g per 100ml, effectively dodging the tax.

Despite the initial bemoaning of its new recipe, punters also seemed to take to it, with the company reporting that since changing the formula, regular Irn-Bru had upped its volume share of the UK carbonates market by 4.2%.

READ: AG Barr loses some fizz as it eyes “more challenging” market in 2019 amid regulation and changing consumer dynamics

While the group’s gross margins did decline around 43 basis points in the year to 43.9%, less than half of Fevertree's own fall, it was mainly due to inward investment as well as carbon dioxide shortages and a hit to its operating conditions in the summer due to “unprecedented” demand amid 2018’s heatwave, not from the sugar tax.

If the company had refrained from ducking the levy, its margins could have ended up looking a little more like Fevertree’s.

In mid-afternoon trading on Tuesday, Fevertree shares were up 2.4% at 2,602p while AG Barr was up 1.5% at 789p.

Quick facts: Fevertree Drinks PLC

Price: 1907 GBX

AIM:FEVR
Market: AIM
Market Cap: £2.21 billion
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