Dr. Pepper’s Much Needed Non-Carbonated Growth Could Come From Snapple Tea

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

Amid continual decline in carbonated soft drinks (CSDs) in the U.S., both the beverage behemoths The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP) witnessed 1% declines in soft drink volumes through March. Unit sales for the third largest soft drink company by volumes in the U.S. Dr Pepper Snapple (NYSE:DPS) also fell 1% during this period, reaffirming the trend of contracting soda sales in the domestic market, where the CSD category declined for the ninth consecutive year in 2013. However, while the non-carbonated beverage (NCB) category comprising bottled water, juices, ready-to-drink (RTD) teas, and sports drinks continues to grow in the U.S., Dr. Pepper’s still drink portfolio hasn’t been able to grab a substantial portion of this growth. While still beverage volumes for both Coca-Cola and PepsiCo rose 3% and 2% respectively in the first quarter in North America, Dr. Pepper’s NCB bottler case sales in the region fell 2% year-over-year. [1] [2] This is mainly due to the absence of strong Dr. Pepper brands in some of the fastest growing segments of the non-sparkling beverage category such as energy drinks, sports drinks and bottled water.

However, Dr. Pepper is well positioned in the RTD tea category on the back of strong sales for the flagship drink Snapple. Going forward, volume-growth in the budding RTD tea category might boost sales for Dr.Pepper’s North America NCB division, which constitutes just over one-fourth of the company’s valuation by our estimates. We have a price estimate of $54.23 for Dr Pepper Snapple, which is around 8% lower than the current market price.

See Our Complete Analysis For Dr Pepper Snapple

RTD Tea Category Bubbling With Growth Potential

As consumers look to shift away from sugar and calorie-fueled beverages such as CSDs, RTD tea has become one of the fast growing segments of the U.S. liquid refreshment beverage (LRB) market. Apart from acting as an alternative for sodas, tea is a convenient and healthier hydrant containing antioxidants that boost metabolism. While the overall wholesale tea sales in the U.S. amounted to $10.41 billion in 2013, up 6.2% year-over-year, RTD tea remained the largest segment constituting almost half the net sales. [3] According to our estimates, RTD tea contributed only 4% to the net volumes in the U.S. LRB market last year. Just for reference, CSDs constituted 43% of the net volumes, while sports drinks, the other budding segment bearing a healthier hydrant perception, constituted 4.6%. Due to the growing demand for iced tea as a healthier refreshment drink, coupled with low current penetration levels, the U.S. RTD tea segment is expected to generate sales of $5.3 billion in 2014, up from $5.1 billion last year, and grow at a CAGR of over 6% till 2018. [4] In fact, while we estimate the overall beverage industry to see volumes rise by 9% between 2013-2018, RTD tea is expected to grow by 11% during this period, outpacing the growth in the overall market. [5]

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Snapple Continues To Rise Despite Fall In Dr. Pepper’s NCBs

While Dr. Pepper’s NCB segment declined 2% in 2013, the flagship tea brand Snapple’s volumes rose 2%. [6] This trend continued through the first quarter this year, with Snapple volumes rising 3%, despite the overall category suffering 2% volume-contraction. [7] Snapple was one of the first few established RTD tea brands in the U.S., along with the Arizona and Lipton tea brands. These three brands own the eight highest selling RTD tea brands among them, with Lipton and Arizona accounting for 19% and 16% of the value share in this segment respectively. [8] Snapple and Diet Snapple together hold a market share of 8% with sales of over $400 million last year. While Lipton and Arizona together have been able to grab a significant chunk of the RTD tea segment owing to a wide variety of products and lower prices, Snapple has positioned itself as a premium tea brand.

Tea prices plummeted last year to an all-time low and are expected to remain in sufficient supply over the next few years. [9] Supply might not be hampered as over three dozen countries produce tea, and no import taxes are levied on tea, barring minor exceptions. This could keep the prices of RTD tea low, and as affordability improves and consumers pay more attention to the tea category, sales of the premium Snapple brand could continue to grow.

Possible Upside Potential For Dr. Pepper

Snapple could continue to leverage its strong brand recognition in the domestic market and positive consumer sentiment regarding RTD tea, and bolster volume-growth for the company going forward. We currently estimate Dr. Pepper’s NCB market share in North America to slightly grow in the near team and then remain constant at around 3% till the end of this decade. However, boosted by the possible growth in Snapple and the overall RTD tea market, if the company’s market share rises to 3.5% by 2020, there could be a 4% upside to our price estimate for Dr. Pepper.

Distribution Outside The Americas Could Further NCB Growth

Dr. Pepper mainly operates in North America, which comprised 92% of the net volumes in 2013, whereas the rest 8% was constituted by Mexico and the Caribbean. However, the company reacquired the distribution rights for Snapple and other non-sparkling beverage brands in certain parts of Asia-Pacific, including Australia, Malaysia, Singapore, China, Hong Kong, Japan and South Korea, from Mondelēz last year. Although Dr. Pepper announced that this deal did not have any material impact on the company’s fiscal 2013 earnings, increasing reach of the Snapple brand in these countries could further boost NCB volumes for the company in future. In particular, China already has a large appetite for tea products, and with the Chinese having affinity for premium beverage brands such as the coffee brand Starbucks, Snapple could also possibly unlock the vast potential of the RTD segment in the country. [10] International expansion could add incremental volumes for Dr. Pepper in the long term.

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Notes:
  1. Coca-Cola 10-q []
  2. PepsiCo 10-q []
  3. Wholesales tea sales in the U.S., statista.com []
  4. RTD tea production in the US“, January 2014, prweb.com []
  5. RTD tea in the U.S., May 2014, euromonitor.com []
  6. Dr. Pepper 10-k []
  7. Dr. Pepper 10-q []
  8. Sales of RTD tea brands in the U.S., statista.com []
  9. What the tea leaves say about industry growth, teausa.com []
  10. RTD tea in China, June 2014, euromonitor.com []