Dr. Pepper Backs Its Diet Plans To Regain Shape In The Domestic Market

Dr Pepper Snapple (NYSE:DPS) holds the third front in the U.S. carbonated soft drinks (CSD) market behind The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP), both of which account for over 70% sales in this category. However, unlike its competitors, the highs and lows of the beverage industry in the domestic market are more significant for Dr. Pepper’s business. For Coca-Cola, the leader of CSDs in the U.S. with 41% market share, domestic fizzy drinks constituted only one-fifth of the company’s revenues in 2013 by our estimates. On the other hand, PepsiCo has its booming snacks division, which contributes more than half to its top line. The company also expects two-thirds of its revenue growth to come from the snacks market (division wise) and emerging economies (geography wise) in 2014. In comparison, Dr. Pepper generates more than two-thirds of its sales from CSDs in the U.S., and has no immediate plans of international expansion. The recent efforts to combat health problems and consequently proposed soda taxes in some U.S. states could hinder Dr. Pepper’s growth in its most crucial market.

But despite the constricting market size of CSDs in the U.S., which reduced for the ninth consecutive year in 2013, Dr. Pepper remains hopeful of a turnaround or at least a steady growth rate in the long term in this market. The company has stepped up marketing spend on its TEN platform and plans to introduce new diet sodas this year. We have a price estimate of $49 for Dr Pepper Snapple, which is around 5% lower than the current market price.

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Dr. Pepper’s Volumes Could Be Hit By Imposed Soda Taxes

In a bid to combat looming health problems such as obesity and diabetes, states such as California and Illinois have proposed taxes on sugary drinks (including syrups and flavor packs). ^{[1] [2]} San Francisco looks to impose a two-cents-per-ounce tax on all sugary drinks, which still has to meet the allegiance of two-thirds of the voters. Since the legislators plan to use these tax proceeds for medical services and health initiatives, voters might be in favor of the tax. In addition, Illinois also proposed a statewide soda tax of one cent per ounce this year, which will effectively increase the price of a 24-pack soda case by $2.88. As CSD making companies and bottlers will look to pass these extra costs on to consumers, a rise in prices could hamper the demand for sugary drinks.

• Loss Of Price Point Advantage

CSDs are already losing consumers to healthier beverage alternatives such as natural fruit drinks, carbonated water and sports drinks. Energy drinks are also taking away market share from CSDs owing to their attractive packaging and successful marketing strategy of targeting young adults. The one main advantage for fizzy drinks over these budding segments has been its low pricing. Companies have looked to provide discounts and lower prices of their soda offerings to attract consumers. However, as the price of a 24-pack soda case will nearly double due to the added tax, more consumers might make the shift away from sugary drinks.

• Loss of Core Customer Base

As more than one in three people in the U.S. are obese, the first lady Michelle Obama has introduced a proposal according to which logos and advertisements of sugary drinks will no longer appear inside schools. ^[3] As part of the 2010 Healthy, Hunger-Free Kids Act, the administration had already restricted the amount of calories and sodium permissible in school beverages last year. This move could further hamper sales of sugary drinks as youngsters form their core customer base.

Assuming uniform distribution of beverages throughout the country, over 350 million gallons of Dr. Pepper CSD volumes come from California and Illinois. These two states together form 16% of the U.S. population, which means that a 6% decline in volumes in these regions alone could cause a 1% decline in the overall U.S. CSD market in terms of volumes.

Dr. Pepper Reaffirms Commitment To CSDs And Diet Sodas

As the domestic market looks to shake-off its soda habit, Dr. Pepper has announced the possible launch of naturally sweetened 60 calorie versions of some of its brands this year. ((“Dr. Pepper earnings transcript“)) Although having six times as many calories as the TEN lineup in a 12 ounce bottle, the company hopes that consumers might prefer naturally sweetened sugary drinks, which still have less than half the calorie count of regular CSDs (150 calories per 12 ounce). The decision to tryout natural sweeteners comes as diet soft drinks containing the artificial sweetener aspartame registered the steepest decline in the U.S. beverage market last year. According to the Wall Street Journal, retail sales of diet sodas fell by 6.8% through November. ^[4]

Dr. Pepper’s low calorie TEN platform suffered an 8% decline in dollar sales through September, while volumes for the full year fell by 1%. ^[5] Despite the discouraging performance of its TEN lineup, the company plans to spend $30 million on the TEN platform in 2014, in hope to recover sales in this segment. What works for Dr. Pepper’s TEN platform is that 52% of its purchases last year were to consumers who generally don’t drink sugary soft drinks, according to a Nielsen Homescan study. This means that diet drinks are increasing the overall market size for CSDs, rather than cannibalizing sales of regular soft drinks. Dr. Pepper’s naturally sweetened diet drinks and the TEN lineup might offset the possible decline in the company’s U.S. volumes in the coming years.

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1. “Illinois senate savors soda tax“, February 2014, cspnet.com [↩]
2. “Soda wars bubble up across the country“, February 2014, healthland.time.com [↩]
3. “Rules to limit marketing unhealthy food in schools“, February 2014, wsj.com [↩]
4. “New low calorie coke may be on the way“, December 2013, nypost.com [↩]
5. “Diet decline endures“, October 2013, cspnet.com [↩]