3 AIM Stocks to Satisfy Investors' Sweet Tooth

But consumers are becoming increasingly health conscious, with more people now dissecting ingredient wrappers than ever before. High sugar drinks products have already become a victim, with a new ‘sugar tax’ brought into force in April.

Add to that a consumer base with squeezed pockets, rising ingredient prices crimping margins and a high street culture decimated by e-commerce and the outlook seems bleak.

However, there are bright spots amid the headlines. Brits continue to splash out on occasional treats and there are some choise retailers that are riding that trend. Below, we run the rule over three AIM-listed makers of baked goods investors may be tempted to sink their teeth into.

Hotel Chocolat (HOTC)

Manufacturer and seller of chocolate, Hotel Chocolat listed a third of its business on the stock market through an IPO priced at 148p in May 2016. The stock rose 42% to 210p in a matter of days, before falling back due to the Brexit referendum.

The rest of the equity ownership is split equally between co-founders Angus Thirlwell, current CEO and Peter Harris. This gives fellow investors confidence their interests are aligned with management and means the company has an eye firmly on the longer term.

While heavy investment in its future growth means returns, margins and profitability are all lower than they should be, Matt Evans, manager of the Investec Smaller Companies fund, says the end goal is clear.

There is a clear and tight management of brand identity, Evans adds. Hotel Chocolat focuses on cacao being the star of its products, rather than sugar. As a result, it should be well placed to navigate any future crackdown on sugar content in foods.

It also sources its ingredients responsibly, investing in both its farmers and their communities. “That is increasingly important and relevant and actually positions it really well as a consumer brand now that understands its responsibilities in the wider world,” adds Evans.

While the UK is still a key driver of growth, and it continues to roll out stores nationwide, its international footprint is expanding, with shops in Copenhagen and Hong Kong.

A recent trading update showed full-year revenue for 2018 up 12% to £116 million, with pre-tax profit expected to be in line with analyst forecasts. In the year to July 2017, it paid a maiden dividend of 1.6p per share.

However, shares have performed exceptionally since that immediate post-flotation high of 210p and currently change hands for 345p – a gain of 64%. Therefore, while Evans would like to have a higher weighting to the stock, he sounds a slight note of caution on valuation.

“It’s a stock that I like for the medium to longer term and I think is very well positioned but I am aware that valuation is probably fairly reflecting that given some of the challenges ahead,” he explains.

Patisserie Holdings (CAKE)

Another company that has a high-quality management team that own significant stakes in the business, Patisserie Holdings runs Patisserie Valerie-branded cafes and diners throughout Britain. It makes and sells cakes, pastries, snacks and other food items from these outlets.

Chairman Luke Johnson, who owns over a third of the firm, is a vastly experienced entrepreneur who has headed up well-known restaurant chains like Pizza Express, The Ivy and Giraffe.

But Richard Power, head of quoted smaller companies at Octopus Investments, says there’s a strong team underneath Johnson, too. Executive directors Paul May and Chris Marsh “are very disciplined in what they do and how they manage it”. That adds up to a “fantastically detailed management team”.

That store roll-out is a key consideration for investors, and Power, who runs the FP Octopus UK Micro Cap Growth fund, notes that management have been extremely disciplined on that count, sticking to 20 new stores a year and not stretching themselves.

Meanwhile, it should be able to navigate the headwinds of higher wage costs as it runs a centralised kitchen model, which means it does not need a chef in each of its stores, reducing employer count. Slices of cake and coffee are also generally high-margin products.

The firm is also highly cash generative, with Power expecting it to announce a cash pile of over £30 million at full-year results due out next month. Phil Harris, manager of the EdenTree UK Equity Growth fund, notes there’s plenty of options for this excess cash, including the possibility of a special dividend, or acquisitions.

The latter is more likely, and something Power also mentions. “On normal deal metrics, and given the level of cash in the business, any acquisition would be materially earnings enhancing,” says Harris. One purchase that could be in the pipeline is artisan bakery Gail’s, which is currently owned by Johnson.

Having floated back in May 2014 at 170p, the stock hit an all-time high 492p in early June – a gain of almost 200%. But that’s not surprising – the firm has delivered earnings per share growth of 20%-plus per year over the past four years.

“I think they’re forecasting 15.5% EPS growth this year and I’m sure they can do a bit better than that,” adds Power.

Looking further forward, 20 more successful store openings over the next five years add another 100 outlets to its current 200-strong portfolio.

“So, you can see, for patient long-term investors, that over the next five to 10 years this business could be generating significantly higher profits than where it is today,” concludes Power.

Finsbury Food (FIF)

Finsbury Food makes and supplies baked goods to a range of outlets, from big supermarkets to wholesalers and smaller bakeries. It supplies confectionery for Thorntons and makes Disney-branded cakes, as well as healthier treats for Weight Watchers.

This varied exposure reduces the group’s overall risk level, according to Graham Spooner, investment research analyst at The Share Centre. This is important in a tough environment for retailers and also opens up the possibility of expansion in both the UK and Europe.

It’s also been acquisitive over the years and its purchases have been “well managed”, helped increase the group’s scale and provided it with significant earnings potential, Spooner adds. It did, though, have to close its loss-making Grain d’Or business this time last year.

A more established stock market company than the previous two firms, the company has been a strong long-term performer since the financial crisis. Shares have surged tenfold since its December 2008 low at 12p to 122p today.

The shorter-term history has been more volatile, with shares trading at the same level they were two years ago. Still, Spooner remains a fan, outlining it as one of his ISA stock picks back in March.

The company recently said overall revenue in the year to 30 June declined 3.4% year on year, though that was due to its historically loss-making Grain d’Or business, which was closed last August. Pre-tax profits are expected to be in line with market forecasts.

Spooner notes that debt levels have fallen substantially, which enables the firm to pay dividends and invest in the business to increase growth. Last year’s dividend grew 7% to 3p, giving a yield of 2.45%.

“We like Finsbury Food primarily because of its diverse customer base, good relative value and future potential,” concludes Spooner.