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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 58% of the volumes of the drink Dr Pepper being distributed by bottlers affiliated with Coca-Cola and PepsiCo, in 2015.
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.
Dr Pepper has increased its full-year guidance after Q2 results
Dr Pepper raised its full-year core EPS guidance, after net sales rose 2% year-over-year on a 1% rise in sales volume in Q2. The company has beaten consensus EPS estimates for four consecutive quarters, and now expects core EPS to be in the $4.27 to $4.35 range, up from the $4.20-$4.30 range forecast previously, for 2016.
Allied brands help grow Dr Pepper's non-carbonated segment
Allied brands allow Dr Pepper to leverage its large scale distribution network and participate in growing emerging categories where it doesn't have a considerable presence as of now. The company is deriving high volume growth from its allied brands, which is expected to continue this year. In fact, with more cash on hand, Dr Pepper might look to invest in other smaller brands with growth potential, like its $20 million investment in the Gatorade rival sports drink brand BodyArmor last year.
The allied brands growth is included in the packaged beverage volumes for Dr Pepper, which is the distribution wing for these small but fast growing brands, such as Bai 5, Vita Coco, etc. At the gross margin line, the allied brands tend to carry lower gross margin because they have somebody else's manufacturing profit in there, but are good contributors to Dr Pepper's operating profitability. Allied brands form a small proportion of net volumes at present, but are an important factor of growth.
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 almost 1% market share from its competitors in four years, but because of the slowdown in the overall demand, volume sales are expected to grow only modestly, if at all. Going forward, there could be hardly any movement in the company's North America CSD market share of 19.7%.
Dr Pepper Snapple is heavily dependent on carbonated soft drinks (CSDs)
Dr Pepper is the perpetual third in the U.S. CSD market behind Coca-Cola and PepsiCo, both of which have a considerable portion of their revenue come from outside the U.S., which further boosts their overall CSD revenue, compared to that for Dr Pepper. In 2015, while 46% and 56% of Coca-Cola and PepsiCo's net sales came from the U.S., a larger 89% of Dr Pepper's revenue came from the domestic market. Dr Pepper is more dependent on CSDs than both Coca-Cola and PepsiCo are, with 82% of its net volume in this beverage category.
Coke and Pepsi's CSD revenue is ~6x and 2.5x respectively of Dr Pepper's CSD revenue, but almost 80% of Dr Pepper's net revenue comes from this category, reflecting the dependence on sodas for the Texas-based manufacturer. Considering that ~80% of Dr Pepper's net revenue comes from CSDs and ~90% of the net revenue comes from the U.S., the declining demand for CSDs could be alarming for the company.
However, Dr Pepper has managed to extract growth in this segment despite the mature nature of the U.S. CSD market and stronghold of both Coca-Cola and PepsiCo, who together hold close to 70% of the market share. How Dr Pepper has managed to grow is also because of its relatively small market share. Dr Pepper is taking away share from other companies, especially PepsiCo, which has lost share continuously in the last few years, in a mature U.S. CSD market. Dr Pepper's North America CSD volume sales have grown at a CAGR of 2.2% between 2012 and 2016 (estimated).
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 (~6 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.
Positive package and pricing mix to drive growth in revenue
Dr Pepper has been able to grow its revenue per case due to positive package and price mix, which has boosted its CSD revenue in North America (U.S. and Canada), which formed 92% of the company's net sales in 2015. Companies are moving to single-serves, which have higher price per unit, thus boosting the revenue per case. Although Coca-Cola and PepsiCo emphasized smaller packs before Dr Pepper did, the latter is catching up, and could continue to see growth in CSDs due to the expected rise in its revenue per unit volume.
The company expects around 3 percentage points of positive price and package mix impact on the top line for the full-year, of which around 2.5 points is expected to come from smaller CSD packages and brands such as Snapple, Clamato, and its allied brand portfolio.
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 2009-2015, as Coca-Cola and PepsiCo increased their focus overseas. The company's market share stood at 19.7% in the North American CSD market in 2015. Going forward, as North American CSDs is a mature market, we don't expect any sharp rise in the company's market share. However, we do expect Dr Pepper to increase its share to slightly over 20% by the end of our forecast period.
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 in the U.S. However, Dr Pepper has been able to consistently improve its volume share in an otherwise mature CSD market. In fact, according to Beverage Digest, the staple Dr Pepper drink grew volumes by 0.1% last year, outperforming both Coke and Pepsi-Cola, while the CSD category declined 1.2%.
- 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. 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. In 2015, PepsiCo and Coca-Cola formed 26% and 20% respectively of Dr Pepper's beverage concentrate sales revenue.
- Dr Pepper Snapple is continuously making distributional gains. The company also improved its fountain coverage, adding just under 42,000 new fountain valves, providing consumers with thousands of additional sampling opportunities.
- Dr Pepper has room to grow
- Dr Pepper has the smallest share out of the big 3 in the U.S. CSD market. As in the past, with increasing distribution capabilities and reach, Dr Pepper could take away more share from its compatriots Coca-Cola and PepsiCo.
Back to Company Overview
- Use of aspartame in diet sodas could decrease Dr Pepper's market share
- Dollar sales for diet soft drinks fell 3% y-o-y in 2015, even as sales for the entire carbonates category in the U.S. rose 6%.
- 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 last year, replacing it with sucralose, which carries a relatively better customer perception. However, the diet category still continues to underperform the entire CSD segment, reflecting how customers are still not appeased by the efforts made by companies in this category.
- 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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