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Investment Overview for Dr Pepper Snapple (NYSE:DPS)
WHAT HAS CHANGED?
Dr Pepper is growing faster than both Coca-Cola and PepsiCo
Dr Pepper might be one of the biggest beverage manufacturers in the U.S., but the company is considerably smaller than its compatriots, whose businesses spread across the world. Coca-Cola and PepsiCo are roughly 12x and 10x as big as Dr Pepper, respectively.
The top line growth for Dr Pepper has outpaced that of its competitors, mainly as negative currency translations have arrested growth for both Coca-Cola and PepsiCo, but also because of stagnating growth opportunities for both these companies, who are already omnipresent in the country. Dr Pepper still doesn't exercise a lot of control on its shipping and store deliveries, with 59% of the volumes of the drink Dr Pepper being distributed by bottlers affiliated with Coca-Cola and PepsiCo, in 2014.
The domestic market has been kind to Dr Pepper, which is expected to grow by more than the anticipated growth for both Coca-Cola and PepsiCo in the U.S. The P/E ratios suggest that Dr Pepper is the cheapest stock out of the three. While the stronger dollar, and volatility in some emerging markets, are choking growth for Coca-Cola and PepsiCo, Dr Pepper seems to be better poised to grow its top line and further expand margins.
At-home carbonation market could help lift sales for the ailing soft drink segment
As sales of carbonated soft drinks (CSD) continue to fizz out, at-home carbonation emerged as an additional platform for soft drink consumption. This market might not be able to bring back consumers to the CSDs, but due to the ease of carrying compact flavor sachets, and the convenience of in-house consumption, the intake rate of avid customers could increase.
Coca-Cola and Dr Pepper are readying their attack on the at-home carbonation market. Keurig Green Mountain, which makes novelty coffee and owns Keurig brewers, is coming out with its much-awaited at-home carbonation system called the Keurig Kold. Last year, Coca-Cola bought a 10% stake in Keurig Green Mountain, and raised it to 16% in May. Later, Dr Pepper Snapple announced its own distribution deal with Keurig. Coca-Cola and Dr. Pepper will introduce some of their beverage offerings with the Keurig Kold Machine, penetrating the do-it-yourself hydration category themselves.
Below are key drivers of Dr Pepper Snapple that present opportunities for upside or downside to the current Trefis price estimate:
North America CSD
- North America CSD EBITDA Margin : EBITDA margins for the North American CSD segment of the company showed flat to negative growth between 2011-2013 primarily because of high commodity prices. But cost of sales decreased to less than 41% of the revenues in 2014 (from 42% in 2011) to boost margins. Should the cost of sales rise going forward, and we see the long-term margins falling to 23.5%, we could see a 10% downside to the Trefis price estimate. At the same time, if the cost of sales soften and the company is able to touch margins of 30%, we could see an 10% upside to the Trefis price estimate.
Dr Pepper Snapple is the third largest Liquid Refreshment Beverage (LRB) company in the U.S. with further presence in Canada, Mexico, and the Caribbean. Dr Pepper Snapple is a market leader in the flavored Carbonated Soda Drink (CSD) segment with its flagship drink, Dr Pepper. Besides CSD, the company is also present in juices, ready-to-drink (RTD) teas, and mineral water, among others. Some of the company's most valuable brands are Dr Pepper, 7UP, Canada Dry, Sunkist, Crush, and Snapple.
Dr Pepper Snapple was formed in 2008 as a spin-off from Britain's Cadbury Schweppes. Cadbury Schweppes separated the Americas beverages from its global confectionery business and the entity thus formed was labeled Dr Pepper Snapple.
Dr Pepper Snapple derives its value primarily from its North American CSD operations.
Declining sales of diet carbonated soft drinks to further decrease Dr Pepper Snapple's volumes
Low/no calorie soft drinks are presently the worst performing category of the U.S. beverage market. Dr Pepper Snapple uses the artificial sweetener "aspartame," which has a negative customer perception, and is also known to leave a bitter aftertaste. Due to this, sales of the company's TEN product lineup declined 1% during 2014.
Unless a new alternative is found, Dr Pepper Snapple's diet soda volumes might continue to fall.
Dr Pepper Snapple's market share in the North America might remain stagnant
CSDs in the U.S. is a mature market, where most of the revenue is constituted by three main players: Coca-Cola, PepsiCo, and Dr Pepper. This market has consolidated over time and growth rates are expected to remain flat to negative in the next few years.
Dr Pepper has managed to nab only 0.4% market share from its competitors in four years. Going forward, there could be hardly any movement in the company's North America CSD market share of 17.1%.
Dr Pepper Snapple relatively unaffected by the negative impact of a strengthening U.S. dollar
While markets outside the U.S. form approximately 55% and 50% of the net sales for Coca-Cola and PepsiCo, respectively, only 12% of Dr Pepper's top line is formed by international markets. (In 2014, 4% and 8% of the net sales came from Canada and Mexico and the Caribbean, respectively). The impact of depreciating foreign currencies is the least on Dr Pepper.
PepsiCo expects currency translations to drag down full-year net sales and core EPS by 9 and 11 percentage points, respectively. On the other hand, currency is also expected to be a 5 point headwind on Coca-Cola's net revenues in 2015. In comparison, the falling Canadian dollar and Mexican peso are expected to be only a 2 percentage point headwind on the financial results for the Texas-based Dr Pepper, which is not exposed to the more volatile currencies, such as the Russian ruble and Venezuelan bolivar, which have both dented reported sales for Coke and Pepsi in recent times.
Possible decline in Mexico volumes due to high obesity and diabetes rates
Mexico has the world's worst obesity rate of 32.8%. In addition, the country also has a high diabetes rate of 9%, as compared to 7.7% for the U.S.
The President of Mexico has called for a "change in culture," urging people to live a healthier lifestyle and consume less CSDs. This might hamper Dr Pepper's volumes in the future.
In addition, the Mexican government imposed an added tax of one peso (~7 cents) on a liter of fizzy drinks at the beginning of 2014, in a bid to fight health problems. As approximately half the country's population lives below the national poverty line, rising beverage prices could dissuade customers from consumption.
Dr Pepper Snapple's bottling agreements with PepsiCo and Coca Cola Co give it a greater foothold in North American markets
Dr Pepper Snapple struck two bottling agreements in 2010, one with Pepsi and the other one with Coca Cola. These contracts are to be for a period of twenty years, after which they are renewable. Under the agreements, Dr Pepper Snapple will provide beverage concentrates of certain brands to Pepsi and Coca Cola who will then bottle, market and distribute it in the U.S. and Canada. The agreements give the company access to areas which have typically had low per capita consumption of Dr Pepper Snapple brands.
Dr Pepper Snapple received one-time non-refundable fees of $900 million from PepsiCo and $715 million from Coca Cola, which have been recorded as deferred revenues. The agreements provide the company with healthy cash flow as well as add stability to its revenues.
Trefis Forecast Rationale for North America CSD Market Share
North American CSD Market Share is Dr Pepper Snapple's share (by volume) in the Carbonated Soft Drinks (CSDs) market in the North American regions of the U.S. and Canada.
Dr Pepper Snapple had been able to increase its market share very slightly through 2009-2014, as Coca-Cola and PepsiCo increased their focus overseas. The company's market share stood at 17.1% in the North American CSD market in 2014. Going forward, as North American CSDs is a mature market, we don't expect any sharp rise in the company's market share.
Trefis considered the following factors for its forecast:
- Strong brand loyalty among Dr Pepper and Diet Dr Pepper's brands
- The company boasts of its flagship drink Dr Pepper as having a unique flavor. Within the CSD segments, colas have multiple brands with very little taste variation. However, Dr Pepper enjoys strong customer loyalty since no rival drink has a similar taste. The company enjoys a dominance in the 'flavors' category.
- Dr Pepper and Diet Dr Pepper are two of the very few beverages within CSD that have consistently been able to increase the volume despite an overall decreasing market size.
- Volume growth in this market is hard to come by, and is made even tougher due to the dominance of Coca-Cola and PepsiCo, which together account for almost 70% of the segment volumes. However, Dr Pepper has been able to consistently improve its volume share in an otherwise mature CSD market. In fact, the staple Dr Pepper drink grew volumes by 0.5% last year, outperforming both Coke and Pepsi-Cola, and consolidating its position as the fifth-highest-selling soft drink in the U.S.
- Renewed focus by PepsiCo on its soft drink portfolio
- PepsiCo spends almost 5x the money spent by Dr Pepper on advertising and marketing. Although PepsiCo also spends on snack foods and has half of its business outside the U.S., the company has invested a significant amount in its U.S. beverages division, in a bid to fuel growth in its ailing soda business. PepsiCo also sponsored the Superbowl along with tie-ups with 50 Cent and several movies. This can potentially affect Dr Pepper Snapple's market share negatively.
- New entrants such as Kraft can potentially eat up Dr Pepper Snapple's CSD market share
- New companies which are entering the CSD market are smart enough to launch only 'Diet' and 'Natural' beverages. The association of the new entrants with healthier products can potentially hurt Dr Pepper Snapple in the long run as the established soft drink companies are sometimes blamed for promoting obesity.
- Dr Pepper has been scaling up production and distribution capacity in North America
- Dr Pepper Snapple's bottling agreements with PepsiCo and Coca-Cola give it a greater foothold in the North American markets. The agreements were formed in 2010 for a period of 20 years. The agreements give the company access to areas which have typically had low per-capita consumption of Dr Pepper Snapple brands.
- Dr Pepper Snapple is continuously making distributional gains. In 2013, the company gained additional shelf space for CSDs in convenience stores, thereby increasing all-commodity volume by 0.3 percentage points in measured channels, and held shelf space in 2014. The company also improved its fountain coverage, adding just under 42,000 new fountain valves, providing consumers with thousands of additional sampling opportunities.
- Deal with Keurig Green Mountain could increase presence
- A development for Dr Pepper that could spur sales by increasing reach and availability of the company's beverage brands, is the deal with Keurig Green Mountain, which makes novelty coffee and owns Keurig brewers, and is coming out with its at-home carbonation system called the Keurig Kold Machine by the Fall of 2015.
- Dr Pepper will look to introduce some of their beverage offerings with the Keurig Cold Machine later in 2015, and hope to improve falling soda consumption rates. At-home carbonation has emerged as an additional platform for soft drink consumption. This market might not be able to bring back consumers to CSDs, but due to the ease of carrying compact flavor sachets and the convenience of in-house consumption, the intake rate of avid customers could increase.
- SodaStream, a maker of at-home carbonation systems, said in 2014 that it estimates that the global market for at-home beverage systems has the potential to grow to $260 billion, while the market in the U.S. could generate a cumulative $40 billion. This estimate uses the aggressive assumption that these systems will penetrate about 87% of the domestic households. However, even if around 30% of the domestic households purchase at-home beverage systems, the U.S. market could grow to $14 billion, providing growth opportunities to both Keurig and Dr Pepper.
- New low-calorie or diet products could fuel growth in share
- Dr Pepper had earlier in 2014 announced plans of launching its naturally-sweetened 60 calorie sodas in the domestic market, and is now expanding the test of these naturally-sweetened diet sodas to three key regional markets. Although having six times as many calories as the TEN lineup, Dr Pepper hopes that consumers might prefer naturally-sweetened sugary drinks, which still have less than half the calorie count of regular CSDs (150 calories).
Back to Company Overview
- Use of aspartame in diet sodas could decrease Dr Pepper's market share
- Diet soft drinks fell by 6% in 2013 and 5% in 2014, more than the decline in the overall soft drink market.
- Consumption of diet drinks such as Dr Pepper's TEN lineup has been targeted due to usage of the artificial sweetener "aspartame." Recent studies have argued that this artificial sweetener can cause serious health problems along with sugar cravings, dehydration, and even weight gain. In addition, aspartame is known to leave a bitter aftertaste.
- Coca-Cola introduced Coke Life in the U.S. in 2014, a low calorie drinks containing Stevia, an artificial sweetener which is considered safe.
- On the other hand, PepsiCo also introduced its own Stevia drink Pepsi True in the U.S. in 2014, and also removed aspartame from its Diet Pepsi this year, replacing it with sucralose, which carries a relatively better customer perception.
- As Dr Pepper's diet offerings contain aspartame, it faces a possibility of losing further market share to Coca-Cola and PepsiCo, which already hold approximately 70% of the market.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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