A Snapshot Of Our $46 Valuation For Dr Pepper Snapple

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

Dr Pepper Snapple is a beverage manufacturer most famous for its flagship carbonated soda Dr Pepper as well as Snapple, a range of non-carbonated beverages. The company’s operations are largely limited to North America, with nearly 93% of its sales coming from Canada and the US in 2011. The company also operates in Mexico and the Caribbean, which accounted for the remaining 7% sales in 2011.

See our full analysis for Dr Pepper Snapple Group

How does DPS earn money?

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The company earns money in two ways:

1. DPS operates a network of 21 bottling plants spread across the US and Mexico. Beverages manufactured in these locations are shipped out either directly to retail stores or store warehouses through the company’s distribution centers. Around 50% of the company’s overall beverage sales are from its own manufacturing units.

2. DPS sells its drink formulations and naming & branding rights to third party bottlers and distributors who then supply the drinks to stores and warehouses. This is the most prevalent way the company operates outside the US, particularly in the Caribbean Islands.

The company earned around $5.9 billion in 2011, up from around 5.7 billion in 2008. EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) margins have declined slightly from around 22% in 2009 to 20% in 2011.

What are the key product segments for Dr Pepper Snapple?

The company’s sales can be broken down into three key segments:

1. North American Carbonated Soft Drinks (CSDs)

This segment includes sales of CSDs in the US and Canada. Some of the most popular brands of the company include Dr Pepper, Sunkist, 7UP, Canada Dry, Crush, Schweppes and Squirt. North American CSD contributed more than 72% to the company’s top line in 2011. According to our estimates, nearly 77% of the company’s stock value is derived from this segment. The segment offers EBITDA margins of around 20%.

Key Trends:

Here are some of the key trends impacting the performance of this segment:

a. Increasing Health Concerns Hurting Demand: Increasing awareness of health-related issues due to consumption of CSDs and intensifying pressure from health advocacy groups is leading to a decline in overall CSD sales in North America. The market has been steadily shrinking for the last few years, and we expect the trend to continue in the future.

b. Competitors chasing emerging economies, giving DPS edge in North America: With declining sales in North America, competitors such as Coca-Cola and PepsiCo are looking for greener pastures in Asia and South America. This is giving DPS an edge in the North American CSD market. The company’s market share has been rising steadily over the last few years, and we expect the trend to continue in the future.

c. Company enforcing stronger pricing, but competition still a worry: As cola companies witness declining volumes in North America, they are stepping up prices to maintain net sales and fight increasing commodity costs. This is true for Dr Pepper Snapple as well. Average revenue per gallon of CSD sold for the company has increased from around $1.69 in 2008 to $1.78 in 2011. Cola companies generally have good pricing power because customers tend to stick to a particular taste. But increasing competition for a shrinking market might see downward price revisions in the future.

2. North America Non-CSDs

This segment includes DPS’s sales of light refreshment beverages (LRBs) such as juices, teas and non-carbonated mixes. Some of the prominent brands owned by DPS include Snapple, Mott’s, Hawaiian Punch, Clamato and Margaritaville.

The sales of LRBs contributed around 21% to DPS’s top-line in 2011. This segment also operates at an EBITDA margin of around 20%.

Key Trends:

a. Overall market to grow as consumers turn away from carbonated drinks: Consumers in North America are increasingly turning away from CSDs due to health concerns. This is leading to a surge in demand for non-carbonated LRBs such as iced teas and juices. Drinks which label themselves as ‘natural’ and ‘healthy’ are seeing particularly strong demand. We expect the overall market to increase from around $30 billion in 2008 to $33 billion by the end of our forecast.

b. Lack of innovation in this segment could hurt DPS’s growth: DPS has focused primarily on its CSD segment in the last few years, choosing to focus on the development of new products and low-calorie variants in flagship drinks such as Dr Pepper. This is helping it carve out a bigger share of carbonated soda sales in North America, but hurting its prospects in the non-CSD segment. If the company doesn’t start focusing on innovation in the non-CSD segment, we could see DPS lose market share to competitors who are becoming more active in this segment. Coca-Cola in particular is strongly focusing on its juices and energy drinks department.

3. Latin America Beverages

This segment includes beverages (both CSD and non-CSD) sold in Latin American countries. The company’s presence in Latin America is largely limited to Mexico and the Caribbean islands. Sales in these geographies accounted for around 7% of the company’s total sales in 2011.

Key Trends:

a. Focus on Latin America: DPS is strongly focusing on Latin America through intensive marketing and targeted, ground-level promotional activity. The company has 3 bottling plants situated in Mexico and this gives it direct access to the Mexican market. We expect the company to significantly increase its presence in Latin America in the near future.

So where does the company go from here?

The company’s most valuable segment – CSDs in North America – should see steady growth in the future, guaranteeing it a steady source of income. Coca-Cola and PepsiCo are particularly vulnerable in the region presently as their strategic attention has been turning towards emerging markets. If the company is able to innovate in the non-CSD segment and maintain its momentum in Latin America, we could see significant upside to the company’s stock.

We currently estimate a $46 price for Dr Pepper Snapple, which is just above the market price.