Dr Pepper Snapple Earnings Bubble Higher On Better Volume Performance, Thicker Margins

Dr Pepper Snapple (NYSE:DPS) reported better than expected third quarter earnings as lower volumes were more than offset by pricing/mix gains, leading to a 1% growth in sales. Furthermore, thicker operating margins, lower interest expenses and a lower effective tax rate coupled with fewer outstanding shares drove adjusted earnings per share (EPS) growth of more than 11% y-o-y. Having delivered adjusted net income of $2.25 per share during the first nine months of the year, the company reaffirmed its full year adjusted EPS guidance range of $3.04 to $3.12. ^[1]

Overall, we believe that Dr Pepper Snapple delivered a relatively strong set of numbers on both the top and bottom line. North American carbonated soft drink (CSD) volumes that make up a lions share of the company’s consolidated sales volume, have been declining at an accelerating pace over the last few years amid growing health and obesity concerns. However, Dr Pepper Snapple’s volume performance was encouraging in view of the overall industry performance despite a 3% pricing/mix gain. The fact that the company was also able to grow its core operating margins despite higher commodity costs should also embolden investor sentiment. ^[1]

Our $50 price estimate for Dr Pepper Snapple will soon be updated to reflect the third quarter earnings announcement.

See Our Complete Analysis For Dr Pepper Snapple

Latin America, TEN Launch Drive Volume Performance

As consumers continue to shift towards healthier alternatives due to obesity and diabetes concerns, the soda slump in developed markets is getting bad to worse. The situation in the U.S. is a key example of this trend – all channel carbonated soft drink (CSD) sales volume in the U.S. declined 1.2% in 2012, slightly worse than the 1% decline in 2011 and the 0.5% decline in 2010. ^[2] Per capita consumption of CSDs peaked in 1998 at about 54 gallons a year. In 2012, the figure stood at around 44 gallons a year. ^[3] Growing consumer awareness about the negative health impact of CSDs has been a major reason behind this trend. A research paper recently published in the American Journal of Public Health concluded: “Soft drink consumption is significantly linked to overweight, obesity, and diabetes prevalent worldwide.”

Dr Pepper Snapple derives ~90% of its revenues from North America and ~80% of its sales volume is made up of CSDs. The company therefore faces significant headwinds from the declining CSD consumption in North America, unlike more geographically diverse players such as Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP). ^[4]

However, Dr Pepper Snapple’s bottler case sales (BCS) volume, which excludes contract manufacturing volume of third-party or private label brands distributed by the company was flat y-o-y, compared to an industry wide decline. This could primarily be attributed to an impressive volume growth in Latin America and the contribution of the newly launched TEN lineup. Although the Latin America business contributes just around 12% to Dr Pepper Snapple’s consolidated sales volume, a sharp 6% volume growth in the region, despite healthy pricing gains, helped the company partially offset lower volumes in North America. ^[1]

Apart from Latin America growth, the nationwide launch of TEN variants of its Core 4 brands (that include 7-Up, A&W, Sunkist and Canada Dry) backed by huge marketing investments also helped Dr Pepper Snapple sustain its BCS volume at last year’s level. The company’s “TEN” offering boasts of just 10 calories per 12 ounce, serving with minimal aftertaste of the artificial sweetener. These drinks contain a mix of high fructose corn syrup and aspartame, which reduces both, the amount of calories as well as the aftertaste effect of aspartame. Following the success of Dr Pepper TEN’s launch, the company carried out a nationwide launch of the TEN variants of its Core 4 brands this year.

As a result, the company’s Core 4 brands sales volume was flat year-on-year during the third quarter. While this could be partially attributed to the huge marketing support provided to the TEN launch, it does tone down fears around the lineup’s performance at a time when diet sodas are performing worse than the regular ones. (See: Dr Pepper Snapple’s Low-Calorie TEN Lineup Can’t Escape The Soda Slump) The company has so far spent $28 million on TEN’s launch this year and expects that figure to top $30 million for the full year. ^[5]

Productivity Drives Thicker Operating Margins

Dr Pepper Snapple’s net sales grew 1% during the third quarter despite a 1% decline in sales volume. This was primarily due to pricing/mix gains realized by the company. Pricing gains also helped in neutralizing the impact of higher sweetener costs during the quarter. Moreover, cost savings from ongoing productivity initiatives at the company resulted in the expansion of its core operating margins by ~50 basis points y-o-y. ^[1]

Dr Pepper Snapple launched a Rapid Continuous Improvement (RCI) initiative in 2011 to drive cost savings of $150 million over the three-year period ending 2013. Despite having surpassed its initial target with cash savings of over $156 million realized so far, the company announced during the earnings call that it will continue to pursue additional cost-cutting measures going forward. ^[5]

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Dr Pepper Snapple Group Reports Third Quarter 2013 Results, investor.drpeppersnapplegroup.com [↩] [↩] [↩] [↩]
2. Special Issue: U.S. Beverage Results for 2012, beverage-digest.com [↩]
3. Water becomes America’s favorite drink again, usatoday.com [↩]
4. Dr Pepper Snapple SEC Filings, sec.gov [↩]
5. Third Quarter 2013 Earnings Call, investor.drpeppersnapplegroup.com [↩] [↩]