Premium British chocolatier Hotel Chocolat (HOTC:AIM) reported a favourable trading update on 12 July which prompted Liberum to upgrade its earnings forecast for the business. The shares have also started to bounce back from a post-Brexit vote sell-off. While the story is interesting, the equity valuation looks very rich which leaves no room for error if a recession grips the UK and prompts consumers to reduce casual spending. That could hurt its earnings.

At 186p, the shares trade on 37.2 times 2016 earnings. That figure drops to 25.8 for 2017 but still relatively high versus other food retailers who derive the majority of revenue from physical stores. Sausage rolls to sandwiches retailer Greggs (GRG) trades on a forward PE of 15.8 and cake shop specialist Patisserie trades on 21.2 times prospective earnings for its current financial year.

The bull case

Guided by co-founder and CEO Angus Thirlwell, the company offers customers accessible luxury at affordable prices through its 85 own stores, cafes and boutiques. It also boasts a strong digital business that includes the innovation-driving, recurring revenue-delivering ‘Tasting Club’.

One of few chocolatiers to actually grow cocoa, Hotel Chocolat’s competitive advantage includes a vertically-integrated supply chain and strong intellectual property in the form of internally-created recipes.

Hotel Chocolat is leading the UK’s rise of craft-style and artisanal chocolate making, but only has 1.5% of a UK chocolate market forecast to grow from £6.4 billion in 2014 to £7.6 billion by 2019.

It acquired an estate in St Lucia in 2006 which contains a 250 year old cocoa plantation. That site now also includes a luxury hotel, restaurant and spa.

The bear case

Aside from valuation, Hotel Chocolat has numerous negative factors. A downturn in consumer spending could see its products removed from shopping lists.

It operates in highly competitive markets in terms of core product and source of revenue. The UK and overseas markets are full of confectionery companies and cafes, and Hotel Chocolat also competes on a broader scale with the UK gifting market which could be anything from flowers to perfume or jewellery. Its products are also subject to seasonal fluctuations in terms of demand.

The company is dependent on a single supplier for most of its liquid chocolate, being Barry Callebaut. It also relies on a single factory that makes 95% of its products. Any setback to this site could cause a major supply disruption.

Large volumes of ingredients are priced in euros, so recent sterling weakness theoretically makes these input costs more expensive. The company has historically hedged exposure to this risk, according to its admission document, but it could be an area to monitor in the future.