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Investors’ Chronicle: Smart Metering Systems, Fevertree, Restaurant Group

BUY: Smart Metering Systems (SMS)

The order book for smart meters rose by 25 per cent to 2.55mn in 2021 as SMS increased its dividend by 10 per cent, writes Madeleine Taylor.

A growing base of installed smart meters led Smart Metering Systems to book a 12 per cent increase in index-linked annualised recurring revenues of £86mn in 2021. 

The Aim-traded company, which installs and manages electricity meters on behalf of energy suppliers, saw underlying pre-tax profits rise by 20 per cent to £18.2mn, after adjusting for the impact of a one-off sale of subsidiary Crail Meters in April 2020. Consensus estimates expect this to rise to £20.7mn at the end of 2022, reflecting the healthy order pipeline for smart meters, which rose by a quarter to 2.55mn.

SMS is a “predictable business”, said chief executive Tim Mortlock, since annual revenues flow directly from the number of meters installed. He said the company currently holds enough stock in its UK warehouses to deliver two-thirds of the 450,000 meters it aims to install this year.

The shares have fallen by 15 per cent in the year to date over concerns surrounding turbulent energy prices, which Liberum said have “unfairly affected the share price” since SMS’s order pipeline, including an exclusivity agreement with Shell, has not been affected.

The pace of meter installations has averaged 30,000-35,000 a month in the first few months of full-year 2022, broadly on track to meet management’s full-year expectation, said the broker, reiterating its “buy” recommendation with a target price of 1,185p.

Meanwhile, the Crail disposal netted Smart Metering Systems £282mn in the last financial year, and helped shore up an ailing balance sheet, which now holds a net cash position of £109mn. 

This puts SMS in good shape to fulfil its orders as well as make progress on plans to add 620 megawatts of grid-scale battery storage facilities over the next five years. The first site in Burwell went live in January, and management said battery storage could account for up to a quarter of Ebitda by the end of 2026.

HOLD: Fevertree Drinks (FEVR)

The luxury mixers brand has cut profit guidance for 2022 as inflationary pressures set to intensify with Russia-Ukraine war, writes Madeleine Taylor.

Optimism over the return of drinking in pubs and bars was not enough to forestall another fall in profit margins at Fevertree Drinks, as the costs of sea freight and bottling continue to rise. 

The high-end tonic maker’s Ebitda is now expected to come in between £63mn and £66mn in 2022, 8 per cent lower than the previous estimate of £69mn-£72mn, owing to “significant uncertainty in relation to input costs in the short term” caused by the Russia-Ukraine war. 

It also posted a fifth consecutive fall in adjusted cash margins, which slumped to 20.2 per cent in 2021, from a high of 35 per cent in 2016. The luxury mixers company put up prices in the UK, but this was not enough to offset higher product and logistics costs, which have risen by 15 per cent and 50 per cent, respectively, between 2019 and 2022.

The cost of shipping products to the US, where Fevertree now makes a quarter of its sales, was responsible for the largest cost increase, but the burden should be reduced as production ramps up at local bottling and canning facilities on the western and eastern coasts of the US.

Margins aside, there were encouraging signs on the sales front. Over the past two years, pandemic restrictions have taken a toll on sales in pubs and bars (the “on-trade” segment), which was still at around two-thirds of pre-pandemic levels in the UK in 2021. Nevertheless, strong sales for drinking at home and 33 per cent growth in the US market helped produce double-digit revenue growth, which management expects to continue in 2022.

At the same time, a long-awaited on-trade recovery has started to show in Fevertree’s largest market in the UK, where sales returned briefly to 90 per cent of pre-pandemic levels at the end of November, before being hit by the spread of the Omicron variant. 

Jefferies kept its target price of 3,100p based on Fevertree’s “long-term growth as a leveraged play on spirits premiumisation trends”, adding that reduced profit guidance “should not come as a surprise to the market” given the recent intensification of inflationary pressures.

The outsourced business model underpinned a year-on-year increase in cash resources, so management felt able to recommended a special dividend of 42.9p a share.

Despite the shares falling by nearly 40 per cent since the start of the year, the stock is still expensive on a forward price/earnings ratio of 39.4. You could argue that historical performance justifies the lofty valuation, but elevated input costs are likely to constrict profits for the foreseeable future. More evidence is needed that it can get its profit margins under control.

SELL: Restaurant Group (RTN)

The relative outperformance of the market is encouraging, but a third annual loss in a row will concern investors, writes Christopher Akers.

Restaurant Group fell to its third consecutive annual loss, despite promising trading against the wider market and a jump in revenue. The restaurant owner, whose main brands include Wagamama and Frankie & Benny’s, posted some promising figures after sites reopened for trading, but finance charges pushed it into the red.

While revenue is still significantly down on 2019, an almost 40 per cent increase this time around is encouraging, albeit from a low base. The company’s restaurants reopened for dining-in on 17 May 2021, after the relaxation of government restrictions on trading, and from that point like-for-like sales in three out of four divisions outperformed both the market — as measured by Coffer Peach industry trackers — and 2019 postings.

In that period, Asian food brand Wagamama was the standout performer. It outperformed the market by 8 per cent and recorded like-for-like sales 15 per cent above its 2019 result. Like-for-like sales in the multi-brand concessions division, which trades primarily in UK airports, plunged by 41 per cent against a backdrop of international travel restrictions.

A higher net finance charge was the culprit in turning a positive operating profit into a pre-tax loss. The company recorded a net £47mn charge against the previous year’s £38mn, up due to a higher interest rate, a chunkier level of debt and a £1.9mn write-off on loan facility fees on old facilities.

New chair Ken Hanna pointed to the balance sheet recapitalisation in the year — £167mn of equity was raised from a placing and open offer and a new £500mn debt package was agreed — and trading levels as reasons for why he thinks the company is set up “well despite the inflationary pressures that continue to impact the sector”.

But it would be unwise to underestimate the economic headwinds hitting the industry, from higher energy costs to labour shortages. Chris Beauchamp, chief market analyst at IG Group, said: “Restaurant Group might find that the respite between pandemic and harder economic times is all too brief.”

Analysts expect the shares to trade on a consensus 22 times forward earnings, below the five-year average of 25 times, and estimate earnings per share of 2.71p and then 5.05p for the 2022 and 2023 financial years, respectively. While there are some positives to take from these results, we aren’t at this point convinced on a recommendation upgrade.

Chris Dillow: Dizzy with success

Joseph Stalin was right, at least in one respect. This is one lesson of Vladimir Putin’s so-far unsuccessful invasion of Ukraine.

People, said Stalin, “not infrequently become intoxicated by successes; they become dizzy with success” and so come to “overrate their own strength”. This seems to have been Putin’s error. Having successfully annexed Crimea in 2014 he thought he could do the same in Ukraine, especially as he thought the “historic unity of Russians and Ukrainians” (the title of an essay he wrote last year) meant Russian troops would meet little resistance.

But what’s this got to do with investing? Plenty, because company bosses, fund managers and retail investors are all prone to the same error. We become dizzy with success, and get high on our supply.

For example, having successfully acquired NatWest, Fred Goodwin — then chief executive of Royal Bank of Scotland (RBS) — thought he could repeat the trick with ABN Amro, ignoring evidence that the payoffs on takeovers were often negative. That decision caused the near-collapse of RBS. Goodwin, like Putin, had become dizzy with success – with disastrous consequences.

His was not an original error, however. As long ago as 1986 Richard Roll proposed a “hubris hypothesis” of takeovers; bosses become overconfident about their ability to merge businesses and so pay too much for acquisitions.

Neil Woodford made a similar mistake. Having performed brilliantly for years at Invesco Perpetual he too became dizzy with success and moved away from what Charlie Munger calls his “circle of competence” (investing in listed companies) to buy small unquoted businesses. You know how that ended.

The mistake, though, is widespread among retail investors too, and bad for us.

The problem arises from the self-serving bias — our tendency to attribute success to our own skill but failure to bad luck.

Of course, being overconfident about your ability isn’t necessarily disastrous. It’s certainly not in the job market where employers actually select overconfident candidates. Nor need it be in investing, if it encourages us to run our winners thereby benefiting from momentum effects.

Sadly, however, the effects of overconfidence don’t stop there. Becoming dizzy with success leads us to trade too much and this is hazardous to our wealth. If you are trading often you are acting upon noise rather than signal and so are in effect simply gambling at bad odds.

What’s more, if you come to believe it is easy to beat the market you’ll take too much risk by underinvesting in safe assets and by overinvesting in more speculative stocks.

Mere knowledge of these errors is, however, not enough. Instead, what we need are institutions and habits that entrench the avoidance of known errors. In companies and governments, such institutions must protect against groupthink and overbearing overconfident bosses. And for retail investors, it must consist of habits that stop us trading too much, acting on our emotions or taking too much risk.

Investing is not a discrete activity separate from the rest of life. It is an exercise in judgment under uncertainty. Deciding whether to buy a share, take over a company, start a war or simply to play an attacking shot at cricket are all manifestations of the same general problem, of how to choose. And the error of overconfidence can be common to all of them. Investing is part of life — which is why it is so interesting.

Chris Dillow is an economics commentator for Investors’ Chronicle

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