BUY: Stock Spirits Group (STCK)--Spirited Growth in Central and Eastern Europe?

Shares: 330
Price: 197.17
Predicted annual dividend income: £10

Regular readers of the DD have no doubt noticed I have been looking to increase my consumer goods exposure of late.

This is especially the case with regards to the beverage sector.

Recently I added FTSE 250 soft-drinks Britvic and I have fairly regularly topped up my holding in FTSE 100 spirits giant, Diageo.

With my new funds I was looking to continue this shift. I had a few options I considered:

1. Top up my Britvic or Diageo holdings. Britvic, in particular, was looking attractive;
2. Open a new position in FTSE 100 beer giant, SABMiller;
3. Add a mid-cap like AG Barr, Nichols or Stock Spirits.

In the end I went for option 3 and recently-listed Buckinghamshire-based Stock Spirits (LON:STCK). 

But why?

Why not the others?

The other options were certainly attractive. Britvic is trading a little below my original purchase price and is showing a 3%+ predicted yield for next year. Diageo is also trading quite low--but above my purchase price--and yielding a predicted 3%+ next year too. Both were tempting.

SABMiller has seen its price slide down to a more reasonable valuation. However, at a P/E of nearly 22 for next year it still seems to me it has a little further to drop before it is attractive. 

In the mid-cap arena both Barr and Nichols have similar issues. Both are trading at P/E ratios of about 21 for next year and have sub-2% yields.

In this context, Stock Spirits looks very attractive indeed.

Why Stock Spirits?

Stock Spirits is a bit odd when compared to my other similar investments. Firstly, it has only been listed since October 2013 unlike most of the other consumer goods companies sitting in my portfolio (although Britvic was only listed in 2006).

It is also not in the FTSE 100 or even the FTSE 250. It had been in the FTSE 250 in August 2014 but was pushed back into the FTSE Small Cap after Reckitt Benckiser's pharma spin-off, Indivior, joined the FTSE 250.

So what appealed to me?

1. Its business sector and products;
2. Its geographical focus;
3. Its value compared to its peers;

1: Attractive Sector: Now, of course, its sector appeal is fairly obvious. The beverage sector--especially alcoholic beverages--is generally considered an incredibly safe and secure growth area. 

Branded goods like those of Stock Spirits attract great pricing power and brand loyalty which means they attract consistent and impressive growth records as well as the added benefit of usually being able to ride out economic volatility with greater aplomb than many. 

Stock Spirits has a number of brands including Stock, Amundsen, Bozkov, 1906, Keglevich, Lubelska, Orkisz, Hammerhead and Zubr. These in turn range across a variety of beverages from brandy to vodka, and limoncello to whisky and herbal bitters to gin. It is quite a range.

What is more, they act as an agency provider for other brands from much larger beverage firms Diageo and Beam Suntory. 

2: Attractive Geographical Focus: This is a critical appeal for me. They operate in a number of Eastern and Central European countries which are seeing growing wealth and disposable incomes. What is more, they are not just "also rans" in these countries.

In particular, they have dominant positions in their two main markets: Poland (58% or revenues) and the Czech Republic (20% of revenues). They also have a very strong position in their third biggest market, Italy (12% of revenues). 

Just a quick look at a breakdown of their position in certain segments in certain countries shows the brand and pricing power they have:

Poland	Czech Republic	Italy	Slovakia
Spirits: 1st Clear Vodka: 1st Vodka-based liqueurs: 1st	Spirits: 1st Bitters: 1st Rum: 1st Total Vodka: 1st	Vodka-based liqueurs: 1st Clear vodka: 2nd Limoncello: 1st Brandy: 2nd	Spirits importer: 1st Fruit distillates: 2nd Bitters: 1st

Even looking beyond these "core" markets they have a very strong presence. In Bosnia & Herzegovina and Croatia their brandy labels take top spot. What is more, they export to over 40+ countries in total.

These are all attractive markets. However, seeing as Poland and the Czech Republic represent such a large part of their revenues it is perhaps best to take a moment to look at these countries further.

It is clear that Poland looks particularly attractive as an operation. The country has seen consistent economic growth since at least 2005 including through the financial crisis. The Czech Republic's growth record is not quite as spectacular, perhaps, but hardly sluggish: 

	2005	2006	2007	2008	2009	2010	2011	2012	2013
Poland	3.50%	6.20%	7.20%	3.90%	2.60%	3.70%	4.80%	1.80%	1.70%
Czech Republic	6.40%	6.90%	5.50%	2.70%	-4.80%	2.30%	2.00%	-0.80%	-0.70%
Italy	0.90%	2.00%	1.50%	-1.00%	-5.50%	1.70%	0.60%	-2.30%	-1.90%
UK	3.30%	2.70%	1.80%	-0.30%	-4.30%	1.90%	1.60%	0.70%	1.70%

You may notice that Poland's growth is slowing. However, growth is expected to speed up to mid- to high-3% for the next few years. All in all, it is clear that Stock Spirits seems to be well placed to benefit from this growth in this entire region of Europe.

Similarly, as we will see from the more quantitative breakdown below, they are in a strong position to be able to expand this position.

Now of course--like all companies with such focused geographical exposure--revenue can be tied very closely to small shifts in those countries. In Stock Spirits case, they have recently been adversely hit by a 15% duty increase in Poland brought in on 1 January 2014. This naturally crimped sales noticeably in its biggest market.

However, what is impressive is how well they handled it. Thanks to their strong brands they were able to raise their prices accordingly--in contrast to rivals. Their market share declined slightly as a result, but was remarkably stable in the circumstances. For me, this was highly encouraging and hopefully once the dust has settled on this change we should see a return to healthy, profitable and sustainable growth.

Good Value

Now lets look at the next attractive part of Stock Spirits: its valuation.

In absolute terms, in contrast to its peers it seems to be running at quite a discount. According to the analyst predictions for this year coming we should see this: 

		EPS	P/E Ratio
Consensus	£	13.15	14.99
High	£	15.84	12.45
Low	£	11.57	17.04
Difference (%)		34.11

Even accounting for the lowest EPS prediction we should see a PE value of 17 which, for a company in such a defensive industry, seems fairly reasonable to me. What is more, assuming the consensus prediction is closer to the mark. A sub-15 PE ratio seems delightfully good value to me.

And for next year:

		EPS	P/E Ratio
Consensus	£	14.91	13.22
High	£	17.42	11.32
Low	£	13.19	14.95
Difference (%)		29.87

Again, here the lowest estimate would suggest a very reasonable PE below 15. I am rather happy with that.

Now, obviously, because Stock is less diversified than a Diageo, SABMiller or the like does mean you would perhaps expect it to trade at a discount. True, but other equally less diversified companies are not showing this sort of discount. As such, I think it is a little unjustified.

Dividends

Being only recently listed, Stock Spirits--obviously-- has little in the way of dividend history. Indeed, last year (2014) was the first year in which they paid a dividend. Being a Europe-focused business they declare their dividends in Euros but pay in sterling. Now, last year's dividend amounted to €0.0375 per share. 

For the next two years analysts predict a yield (in British pence) of 3.54p and 3.85p. This would--on my purchase price--represent a modest yield of 1.8% and 1.95%. 

This yield--although not massive--is pretty solid. However, it is the earnings coverage which really appeals to me. 

Even assuming the worst-case scenario EPS predictions noted above we should see the dividend covered about 3.3 and 3.45 times by earnings this year and next. Taking the consensus predictions we should see it covered about 4 times by earnings for both years. 

For me this suggests the dividend looks extremely healthy and secure.It should also--hopefully--mean that it can grow at quite a click.

For instance, both Nichols and AG Barr, whose size makes for a fairer comparison with Stock Spirits, have their dividends covered about 2.4 times by earnings. 

If Stock Spirits were to do the same trick with their consensus predicted earnings for this year and next we would see a dividend of 5.5p and 6.2p. This would be a yield of 2.8% and 3.15% on my purchase price. This is much higher than the c.2% yields of Nichols and Barr.

Looking at Stock Spirits current dividend policy suggests a different figure. The policy states that:

Assuming that sufficient distributable reserves are available at the time, the Board initially intends to target the declaration of an annual dividend of approximately 35% of the Group's Net Free Cash Flow.

Last year, their free cash flow was  €29.3 million. Assuming this figure is repeated for 2015 and the number of shares remains at 200 million as at present this would produce a dividend of €0.05 per share. At present FOREX rates this would be a yield of about 1.84%. Not bad at all.

Raising a Glass to the Other Figures

Stocks Spirits also looks excellent when other metrics are pulled in. Its debt to equity ratio is a very modest 0.47. This is higher than the likes of Barr and Nichols (readings of 0.1 and 0, respectively) but lower than others mentioned previously.

What is more, they have large cash reserves in the form of €83 million. This amounts to hefty 30.08p per share in cash alone. That is about 15% of the share price in cash alone.

Finally, from my calculations of its book value it seems that it is trading at a premium of about 60% to its book value worth. This compares very favourably to the other companies mentioned earlier (the next best is about a 250% premium).

All in all, it looks a very attractive company indeed.

Stock Spirits and My Goals

So how does this Stock Spirits purchase fit in with my investing goals for the year? Well, to be honest not very well on the face of it.

With a yield well below 2% it is clearly not going to make a positive contribution to my aim of having a portfolio yield of 1.25 times the FTSE All-Share yield (which is calculated as 4.05% at time of writing).

However, recently I have been focusing on building up the growth element in my portfolio. As a result, current low yield has had to be embraced in most cases in order to achieve this. It is therefore little surprise to see that my current portfolio yield is sitting at its lowest level for over 12 months: 3.92%.

This low yield also means that Stock Spirits will have a small effect on my target of £800 in dividend income this year. I have missed the Final dividend payment (in May) but should see an Interim one in September.

It does not add anything to my Beta volatility for my portfolio at present as it is too newly listed for it to register a Beta value.

However, it does help towards my trading charges reduction goal. The size of my purchase meant that the fees only amounted to 1.26% of my total investment. This should keep me comfortably on track  to beat my goal of 1.3% or less for the year.

Conclusion

Overall I am happy with my Stock Spirits purchase. It is an odd one in many ways especially when set aside my specific goals for this year.

However, I think the company has an excellent stable of brands which it is carefully and effectively managing in an exciting number of European countries. As such, it is another investment very much from the long term perspective. I expect to see it dividend growing at quite a rate for some years to come as it consolidates and expands its business.

As a separate company, I think its future looks very bright. However, there is also the strong possibility that the company will be an appealing acquisition for a larger rival. Diageo, Pernod Ricard or Suntory may well find the company highly attractive for the same reasons. Whatever its future offers, I am quite happy to be on board!

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[Image reproduced from Stock Spirits Group]