Questor share tip: AG Barr still a core holding

AG Barr
639p+16½
Questor says HOLD

SOFT drinks group AG Barr said yesterday that it would focus on increasing sales of its brands, which include Irn-Bru, Tizer and Rubicon fruit juices, rather than looking for big acquisitions.

The fizzy drinks maker said revenue was up 5.2pc during the first 15 weeks ended May 11; this is a steady performance and only marginally behind sales growth of 5.5pc reported for the final three months ended January. When compared to the wider drinks market, where sales increased by 1.9pc during the same 15-week period, it shows AG Barr is gaining a bigger share of the soft drinks market.

Encouragingly, the company isn’t cutting prices or spending heavily on advertising to achieve this. Roger White, chief executive, said that prices had held firm or risen in line with inflation and marketing and advertising spend was in line with expectations. This meant that profit margins at AG Barr had held firm.

That is good news for investors because, as sales increase, then profits should also rise when the profit margin is steady.

Mr White said the company has seen strong sales from its water products from the start of the new financial year; the Strathmore bottled water range has expanded its range by offering twist fruit flavours. Traditional brands, such as Irn-Bru, have also increased their range by moving into the ice cream market.

AG Barr is operating with a strong balance sheet. The company said at the start of the year that it would end January with lower debt levels than expected. In its full-year results, the company reported net debt of just £2.1m and house broker Investec is forecasting that it will be in a net cash position within the next eight months, which creates some interesting scenarios for investors.

When a company becomes debt free and continues to grow profits then cash builds up. This can either be used to expand or returned to shareholders. AG Barr has said it will use a portion of this cash to improve its bottling facilities, which means capital expenditure will increase to about £19m, from £13m last year.

Investec estimates the drinks company will still generate free cash flow of £24m in the coming year, and that covers the full-year dividend payments of about £13m, or 11.8p per share, about 2 times. That leaves plenty of room for the dividend to rise at a rate above inflation during the coming years.

Alternatively, AG Barr could go shopping for more brands. The company is now in a stronger position than it was two years ago when it launched the ambitious, but ultimately ill-fated £1.4bn bid to merge with rival Britvic. The drinks company will have a tough trading period ahead of it. A scorching summer in the UK last year was behind strong sales; even if the fickle British summer obliges with a repeat of last year’s warm weather – and you wouldn’t bet on it right now – AG Barr would be doing well to hit double-digit sales growth. If we have a washout summer it will make trading all the more challenging. For the long-term investor, whether the sun shines or not is hardly important, but in the short term it does bring into question buying at this price.

Shares in the FTSE 250-listed drinks group have not run away during the past 12 months, having risen 10pc, exactly in line with the wider index. However, they are by no means cheap and trade on 22 times forecast earnings, a premium to the wider soft drinks sector.

While not a buy at these prices, the company remains a solid investment to hold. The attractive points are the strong balance sheet and cash generation that provide the potential for the dividend to accelerate. The gains from here should be steady and the shares remain a hold.