Morgan Stanley upgrades Britvic rating despite looming sugar tax

Analysts at Morgan Stanley upgraded their recommendation for shares of Britvic on Thursday from ‘hold’ to ‘buy’, explaining that the shares' current level provided an "attractive" entry point, given the outlook for several of the company's main financial metrics over the medium-term, including a projected quadrupling of its free cash flows.

In their research note, they revised their target price for Britvic up to 870p from their prior 680p estimate, telling clients Britvic was set to produce a minimum 15% return at the operating level, courtesy of the completion of its three-year "business capability programme" (BCP) that was set to end in 2018.

The BCP had been focused on increasing the efficiency of the GB business and was expected to deliver significant cost savings.

Indeed, Morgan Stanley forecast "modest margin expansion" - of over 170 basis points at the EBIT level to reach 14.6%, over fiscal years 2017-2020 - driven by operating leverage in the underlying business and the group’s international business breaking even.

The consensus projection for margin growth was for over 90bp. To take note of, each additional ten basis points would boost EPS by 70bp.

Free cash flow generation was also set to boom, the broker said, predicting it would more than quadruple between 2017 to 2020, meaning the shares were offering an estimated 2020 FCF yield greater than 10%.

One potential pitfall was the UK sugar tax, set to be imposed from April, which 28% of Britvic’s GB portfolio will be exposed to but the analysts believed the impact upon Britvic would be "muted".

The analysts justified that assessment by explaining that there was a more developed low/no sugar market in the UK than compared to other key markets where a sugar market had been implemented.

As such, Morgan Stanley projected that the company's revenues would see a steady rise, with increases of 3% in 2019 and 2020, albeit following a 5% dip in 2018 as the company takes a slight hit from the aforementioned sugar tax.

Britvic’s dividend per share was seen rising by 2% in 2018 and by 7% in 2019.

"The upcoming "sugar tax" has been an overhang for Britvic's GB division. However, a well-developed low/no sugar offering (Pepsi Max) and Britvic's overweight position in the on-trade segment give us comfort that the impact will only be relatively minor. Given the characteristics of Britvic in FY19 and beyond we feel that the market should now look beyond the uncertainty around the sugar tax."

"12.5x CY18 EPS is a deeper discount to peers than is justified."

As of 1238 GMT, Britvic’s shares were up 7.11% at 730.50p