Dr. Pepper Earnings Review: Mexico Beats Expectations, Cost-Benefits Improve Profitability

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

Dr Pepper Snapple (NYSE:DPS) reported better than expected Q1 results on April 23, leading to an almost 5% jump in its stock after the announcement. Net revenues rose 1.3% to nearly $1.4 billion in the quarter, with core EPS increasing 40% to $0.74. [1] Headwinds in the U.S. carbonated soft drinks (CSD) market and a lackluster still beverage portfolio hindered growth for Dr. Pepper, as expected. The North America carbonated soft drinks (CSD) division constitutes almost three-fourths of the company’s valuation by our estimates. As consumers shift from sugary sodas to healthier beverage options, bottler case volumes for CSDs fell 1% for the company. This result reaffirms the trend of contracting soda sales in the domestic market, where the CSD category declined for the ninth consecutive year in 2013. In fact, both The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP) also witnessed a 1% decline in soft drink volumes through March. Seeing how diet variants continue to underperform the entire category, beverage companies will now look to provide a natural, safer, and healthier solution to the high-sugar problem. On the other hand, while the disappointing performance of Dr. Pepper’s CSD portfolio in the U.S. reflects current market trends, the company’s still beverages continue to decline, despite an uptick in the overall market. This is mainly due to the absence of strong Dr. Pepper brands in some of the fastest growing segments of the non-carbonated beverage category such as energy drinks, sports drinks and bottled water.

However, Dr. Pepper exceeded expectations in Latin America, where sales grew despite the recently imposed soda tax. In addition, the company’s Rapid Continuous Improvement (RCI) strategy resulted in productivity gains for the company, recording a 4.3% year-over-year rise in operating margins to 18.6%. We have a price estimate of $49.88 for Dr Pepper Snapple, which is around 9% lower than the current market price. However, we are currently in the process of incorporating the latest quarterly results into our forecasts.

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See Our Complete Analysis For Dr Pepper Snapple

Latin America Volumes Grow Despite New Laws

Revenues from Latin America grew by an impressive 17% in the first quarter at currency neutral, bolstered by higher pricing. This division comprises Mexico and the Caribbean, with the former constituting around 90% of the sales. The Mexican government had earlier this year imposed a soda tax of one peso on one liter of sugary soft drinks sold. This tax resulted in higher pricing of beverages as companies looked to protect profitability. A price rise was expected to lower volumes of CSDs due to an anticipated decline in consumer demand. As over half of Mexico’s population lives below the national poverty line, price-sensitive customers could have been dissuaded from soft drink consumption. However, Dr. Pepper managed to carry its Mexican growth momentum into the first quarter, beating analyst estimates. Volumes rose 2% fueled by a double-digit percent growth in the carbonated mineral water brand Penafiel, one of the oldest brands of mineral water in Mexico. In contrast, both Coca-Cola and PepsiCo had reported lower year-over-year beverage volumes in Mexico. This means that Dr. Pepper managed to grab market share from its competitors in the country this quarter. Higher pricing, volume rise, and productivity benefits also caused a whopping 63% increase in segment operating profit.

Still Beverages Drag Down Overall Volumes

Dr. Pepper’s non-carbonated portfolio delivered another disappointing quarter, with volumes falling 2% year-over-year. Following three consecutive years of contracting unit sales, the company’s juice brand Hawaiian Punch reported another 8% decline in volumes. The U.S. fruit beverage market declined 2% last year, hurt by negative consumer perception regarding large sugar and calorie content in juices. [2] In addition to a constricting market size, Dr. Pepper faces stiff competition from Coca-Cola’s Minute Maid and Simply, and PepsiCo’s Tropicana, which together form over half the market volumes by our estimates. With a decreasing market size and share, Hawaiian Punch could continue to record sliding sales numbers. Growth in still beverages for Dr. Pepper came from the tea brand Snapple, which grew 2%. Ready-to-drink (RTD) tea is one of the fast growing segments of the U.S. beverage market, due to the healthier perception of tea, which contains antioxidants that boost metabolism. In the U.S., RTD tea is expected to generate sales of $5.3 billion in 2014 and grow at a CAGR of over 6% till 2018. [3] Snapple could leverage positive consumer sentiment and strong brand recognition to continue growing in the domestic market.

CSDs Continue To Fall In The Domestic Market

Dr. Pepper’s soft drink volumes declined 1% in the quarter, with the flagship drink Dr. Pepper recording 4% fall in unit sales. Volumes of the company’s low calorie TEN lineup remained flat in yet another quarter, hurt by safety concerns over usage of the artificial sweetener aspartame. Dollar sales of Dr. Pepper’s diet sodas fell by 9.6% in convenience stores and measured take-at-home channels in the four-week period ending March 15. [4] The company will now introduce naturally-sweetened 60 calorie sodas in the domestic market later this year. Although having six times as many calories as the TEN lineup, Dr. Pepper hopes that consumers might prefer naturally-sweetened sugary drinks, which still have less than half the calorie count of regular CSDs (150 calories). In addition, the company is also rumored to be in talks to buy 10-16% stake in SodaStream, the pioneer of at-home carbonation systems. The at-home consumption market could add an additional sales platform for Dr. Pepper, going forward.

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Notes:
  1. Dr. Pepper Q1 results“ []
  2. The U.S. liquid refreshment beverage market remained flat in 2013“, March 2014, beveragemarketing.com []
  3. RTD tea production in the US“, January 2014, prweb.com []
  4. Energy drinks on fire, but diet soda still in a funk“, March 2014, foodnavigator-usa.com []