LONDON -- AG Barr (LSE: BAG.L), manufacturer of IRN-BRU and other beverage brands, was able to shake off a damp early summer, reporting market-beating sales growth of 5%. Unfortunately, it would appear this growth came with a price -- or lower price, as the case may be.
Discounting resulted in a drop in revenue from the company's flagship brand IRN-BRU, while its lower-margin range of Barr branded beverages saw volume and sales growth of 10%. Throw in high sugar prices, consumers doing more shopping in grocery stores -- as opposed to impulse shopping at convenience stores -- and spending on marketing, and AG Barr's 5% increase in sales was diluted to a 7% drop in operating profit.
Despite the drop in profitability, the Board raised the interim dividend by 7.5%, providing a yield on current prices of 2.1%.
In a market where customers are cutting back where they can and competitors are driving prices lower in order to maintain market share, there isn't a whole lot a company like AG Barr can do. It needs to spend on advertising to expand brand presence and cut prices to keep up with the market.
That's why despite reported double-digit sales growth in the first seven weeks of the second half, management remains cautious, expecting "trading to remain challenging over the coming months" and implementing cost control measures to protect margins and profitability.
Of course, things might get a bit easier if the proposed merger with Britvic (LSE: BVIC.L) goes through. Not only would this combination reduce competition in the market, but the increased distribution capacity and cost savings available by combining production and distribution operations mean AG Barr can get its cans on more shelves at a potentially lower cost and therefore higher profit.
The shares' valuation has improved over the past two years but, with a price-to-earnings ratio around 19, there is still a lot of growth priced in. Additionally, teaming up with Britvic could provide AG Barr with the cost savings to ward off this tough consumer environment, but major mergers are never easy and come with plenty of risk.
An investor looking to buy these shares now also needs to consider what they are buying. Buying today one would likely soon own an AG Barr with a completely different profile than it currently has. A combined AG Barr/Britvic may have greater coverage of the market and cost efficiency, but the larger company will have different growth prospects and cash flow priorities (taking care of Britvic's 612 million pounds in net debt being the main one).
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