Last Two Weeks In The Beverage World: KO, PEP, DPS And BUD

Beverage stocks have outperformed the S&P 500 index over the last couple of weeks, amid increasing signals of consolidation in the beer market and new health initiatives by major soft drink manufacturers. While Anheuser-Busch InBev (NYSE:BUD) might be lining up a deal to acquire chief rival SABMiller, rumors about a possible PepsiCo (NYSE:PEP) spin-off have again resurfaced this month. PepsiCo’s major competitor and global leader in the soft drinks market, The Coca-Cola Company (NYSE:KO), re-entered a popular citrus drink last week, and also vouched to create and track new corporate wellness programs in a bid to contribute to health initiatives. But the highest growth in stock price in the last couple of weeks was seen by the Texas-based Dr Pepper Snapple (NYSE:DPS), reaching its record high.

The three soft drink giants, Coca-Cola, PepsiCo and Dr. Pepper also announced their aim of reducing calorie consumption through their offerings by 20% by 2025 in the U.S. These companies plan to achieve this through promotion of low-calorie substitutes and smaller packs, which provide lower cumulative calories in one go. Fighting alongside health activists could help these beverage makers not only to spur positive consumer perception but also expand margins, as smaller packs are relatively more profitable.

Below we discuss key events from the last couple of weeks in relation to the beverage companies in discussion.

Anheuser-Busch Inbev

Rumors about a possible Anheuser takeover of SABMiller have been afloat, a deal that could see the former control over almost one-third the global beer volumes. According to the Wall Street Journal, AB InBev is in talks with banks to finance a possible $122 billion deal to acquire SABMiller. AB InBev is presently valued at around $182 billion, almost double the market capitalization of SABMiller, whose stock rose nearly 10% after the rumors surfaced.

We have a $113 price estimate for Anheuser-Busch InBev, which is roughly in line with the current market price. The stock rose 3.46% last week and fell 1.9% this week.

See Our Complete Analysis For Anheuser-Busch InBev

Anheuser’s buyout of SABMiller has been in speculation for years, but couldn’t be realized due to the large amounts of debt taken on by the former to finance its multiple mergers and acquisitions in the last five years such as Anheuser in 2008 and Grupo Modelo last year. But with steadily increasing cash flow and large input cost reductions, Anheuser might now look to acquire SABMiller and lock-in its share in some South American and African markets, where beer is expected to grow at a fast pace. SABMiller’s revenues in fiscal 2014 excluding revenues from joint ventures and subsidiaries amounted to $22 billion, which gives a rough estimate of annual sales that could be added to AB InBev’s top line, following the acquisition. This merger could boost Anheuser’s top line by a massive 50%.

However, this deal could further increase Anheuser’s debt to EBITDA ratio, which the company’s aims to bring down to around 2. Even after the sale of SABMiller’s interest in MillerCoors, its American joint partnership deal with Molson Coors, AB InBev’s net debt to EBITDA ratio could rise to about 6.5, in order to finance the combination. SABMiller is also looking to acquire the third largest brewer in the world, Heineken. Although Heineken rejected SABMiller’s initial bid, the latter might make another bid or look to acquire other smaller brewers such as Diageo, which would then hamper AB InBev’s acquisition prospects.

Coca-Cola

The world’s largest soft drink maker brought back its popular citrus flavored drink Surge, heeding to continual demand by consumers on online portals, last week. Surge was launched on Amazon.com, selling at $14, plus shipping, for 12 packs of 16-ounce cans. The initial demand for Surge remained high, with the drink temporarily selling-out twice on September 15. Gauging the encouraging consumer response to Surge, Coca-Cola might even launch the drink in retail channels in the future, which would then bring the drink in direct competition with PepsiCo’s flagship drink Mountain Dew.

We estimate a $41.86 price for Coca-Cola, which is roughly in line with the current market price. The stock rose by 1.41% last week and remained flat this week.

See our full analysis for The Coca-Cola Company

With dollar sales of  nearly $668 million in measured convenience store channels in the U.S. last year, Mountain Dew was the highest-selling carbonated soft drink (CSD), beating even the popular cola-flavored drinks Coca-Cola and Pepsi. ^[1] Surge was debuted in 1996, but was pulled after sales didn’t catch-up, and the drink failed to compete with Mountain Dew. However, with initial online sales reflecting strong demand, Coca-Cola might once again launch Surge in retail stores, adding another option in the CSD category, which has been ailing amid health concerns and lack of alternatives.

PepsiCo

PepsiCo’s stock has seen a strong rise this year, amid rumors of a possible spin-off of the beverage unit, with the share price reaching a record high of $94.18 last week. The beverage company has been under activist pressure since January to separate the beverages and snacks businesses. While the company’s beverage division is struggling, mainly due to declining CSD sales, the foods division, including Frito-Lay and Quaker Foods, is witnessing steady top line growth and is relatively more profitable. According to activist investor Nelson Peltz, CEO of Trian Partners hedge fund, which holds $1.2 billion stake in PepsiCo, the weak-performing soft drinks division is dragging down the more lucrative snack foods division. According to Trian, the company’s stock could be worth $144 a share following the spin-off.

We estimate a $89.92 price for PepsiCo, which is roughly 3% below the current market price. The stock rose by 3.2% last week and fell 0.75% this week.

See Our Complete Analysis For PepsiCo

However, amid increased investor pressure, PepsiCo has remained committed to deriving benefits from synergies between the two businesses. The company brought in Luke Mansfield, the former European head of product innovation at Samsung, to work in the role of Vice President- global innovation at PepsiCo. The beverage manufacturer looks keen to shrug-off rumors of a possible spin-off and aims to drive sales of soft drinks through increased innovation.

Dr. Pepper Snapple

The third largest soft drink manufacturer’s stock rose to a record high of $64.5 last week, and further rose to $65.42 on September 22. Amid increasing consolidation in the beverage market, Dr. Pepper also looks to strengthen its direct store delivery (DSD) system and leverage in-house distribution to expand margins, by acquiring Davis Beverage Group and Davis Bottling Company, which bottles and distributes Dr. Pepper’s beverage brands. ^[2] This would also help Dr. Pepper to capture downstream margin opportunity and also exercise more control over retail shelf space.

Retail shelf space is significant for Dr. Pepper, which generated over 12% of its sales last year from Wal-Mart, the world’s largest retail chain. CSDs are already losing shelf space to new high-margin attractive entrants such as energy drinks. Moreover, retailers have been looking to reduce shelf space for the ailing Dr. Pepper’s low calorie TEN lineup. Dr. Pepper’s DSD system could provide shelf inventory management and reduce costs of reordering and merchandising for the retailer, aiming to improve sales and margins for the retailer as well.

We have a price estimate of $56.81 for Dr Pepper Snapple, which is around 11% lower than the current market price. The stock rose by 3.73% last week and another 0.93% this week.

See Our Complete Analysis For Dr Pepper Snapple

Direct store delivery allows the beverage manufacturer to bypass third-party and retailers’ distribution centers. By bringing distribution in-house in parts of Pennsylvania and New Jersey, Dr. Pepper could leverage its integrated model to capture downstream margin opportunities. While Dr. Pepper only expects only flat to 1% top line growth this year, the company could increase cash flow by expanding its operating margins. If Dr. Pepper continues to leverage its integrated model and gains from improved operational efficiencies, causing long term margins for the North America CSD division to rise to 26%, up from our current estimate of 23.4%, there would be a 10% upside to our valuation for Dr. Pepper.

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1. Beverage data, cspnet.com [↩]
2. Dr. Pepper press release [↩]