National Beverage Corp. (NASDAQ:FIZZ) has been one of the best-performing stocks of the past 10 years -- at least until recently. The stock is down over 50% from its 52-week high and recently blamed "injustice" for hurting its financial results. The company is referring to a lawsuit alleging that its sparkling water brand, LaCroix, uses artificial additives despite being advertised as "all-natural." Is the company right to blame its weak performance on the lawsuit, or is the lawsuit a scapegoat for more fundamental issues with its sparkling water business?
In the company's Q4 2018 earnings release, CEO Nick Caporella used colorful language to describe the company's disappointing financial results (note: emphasis added):
"We are truly sorry for these results stated above. Negligence nor mismanagement nor woeful acts of God were not the reasons – much of this was the result of injustice! Managing a brand is not so different from caring for someone who becomes handicapped. Brands do not see or hear, so they are at the mercy of their owners or care providers who must preserve the dignity and special character that the brand exemplifies. It is important that LaCroix's true character is not devalued intentionally -- in any way. National Beverage Corp. is and will remain the preeminent innovator that adds zest and authenticity to the 'sparkling water' phenomenon in North America."
The "injustice" refers to a lawsuit filed against the company in October 2018 by a LaCroix customer who thought she was drinking an "all-natural" drink. The lawsuit alleges that LaCroix contains synthetic additives including ethyl butanoate, limonene, linalool, and linalool propionate. Linalool is an oil sometimes used in cockroach insecticide.
Part of the argument may be what is and what is not considered a natural ingredient. For example, the chemical limonene -- which the lawsuit cites -- is a naturally occurring chemical commonly used to provide a lemon flavor, according to Popular Science in an article criticizing the lawsuit.
In its own defense, National Beverage Corp. hired an independent laboratory to certify its ingredients -- something the claimant in the lawsuit did not do. The independent study, which was funded by National Beverage Corp., concluded that no trace of an artificial or synthetic additive was found. The results of the study were announced in January 2019.
Based on the arguments presented by media outlets and results from the lab study, it appears that National Beverage has a solid defense in the lawsuit. However, the bigger question is whether the lawsuit really matters at all.
Weakening sales trends
The key driver of National Beverage's stock price is its revenue growth. As can be observed from the chart below, the rise in FIZZ's stock price from 2015 to 2017 is coincident with accelerating revenue growth. However, the stock stalled out in 2017 as sales growth stalled out and suffered a large decline in 2018 as revenue growth decelerated. Also worth noting is that revenue growth began decelerating long before the artificial flavoring lawsuit hit the company in October 2018.
The more likely culprit of the company's woes is competition. After LaCroix pioneered the sparkling water market in the U.S., competitors including Coca-Cola (NYSE:KO), Pepsi (NYSE:PEP), and private label players took note. In 2017, Coca-Cola acquired Mexican sparkling water maker Topo Chico. Last year, Pepsi introduced its own brand of sparkling water called Bubly. Finally, in supermarkets all across America, private label sparkling water brands have been introduced at prices that undercut LaCroix.
As is commonly the case in the consumer products world, LaCroix appears to be a victim of its own success. LaCroix became insanely popular and successful, reporting blowout sales growth figures for a number of years. However, its success was met with increased competition, which has negatively impacted the company's ability to continue growing.
Valuation is another factor impacting National Beverage's stock price. As a result of strong and accelerating financial results, investors bid up the company's stock price and valuation to epic proportions. At its peak, investors paid over 50 times earnings for the stock. The price to earnings ratio refers to the stock price divided by the company's earnings per share. This metric measures how much investors are willing to pay for each dollar of a company's earnings; the higher the multiple, the more expensive the valuation.
Since revenue growth began to stall out in mid-2017, investors have become less willing to pay an exorbitantly high valuation multiple for FIZZ. In fact, the company's price to earnings ratio has declined from over 50 to approximately 17 today. At the current valuation, the company's stock price is less expensive, but if revenue continues to decline, investors will probably continue bidding down the stock price.
A good case study for investors
The recent rise and fall of National Beverage's stock is a good investing case study for a several reasons. First, the primary driver of the stock price has clearly been the company's revenue growth trends, not a lawsuit as claimed by the management team (although the lawsuit could have impacted revenue trends on the margin). Second, National Beverage's success in pioneering a vibrant new beverage category led to other players taking notice and fiercely competing. Finally, be careful of buying a stock trading at a high valuation like FIZZ did in 2017. Even though revenue growth was fairly robust in late 2017 and early 2018, the stock declined because investors expected a lot more.