Dr. Pepper Snapple Pre-Earnings: Margins Could Expand On Higher Volumes And Pricing

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

Dr Pepper Snapple (NYSE:DPS) is scheduled to announce its third quarter results on October 23. While the S&P 500 Index has declined in the last three months, the company’s stock has grown by over 9%, outpacing the growth in The Coca-Cola Company (NYSE:KO) and PepsiCo‘s (NYSE:PEP) stocks during this period. Dr. Pepper mainly operates in the U.S. and Canada, which together form over 90% of the company’s valuation by our estimates, while the rest is contributed by Mexico and the Caribbean. In particular, we estimate that the carbonated soft drinks (CSD) portfolio in North America generates over 70% of the net sales for Dr. Pepper. As the demand for CSDs continues to decline in the domestic market, we don’t expect a meaningful year-over-year increase in the Texas-based manufacturer’s top line this quarter, in line with the company guidance of flat to 1% revenue growth for the full year.

But Dr. Pepper could generate additional cash flow and thereby create value for shareholders in Q3 by expanding margins. We have a price estimate of $56.81 for Dr Pepper Snapple, which is around 11% lower than the current market price. The company expanded its operating margins by almost 400 basis points to 20% through June. In contrast, Coca-Cola and PepsiCo improved their margins by only 20 and 50 basis points to 23.9% and 15.9% respectively during this period. If long term margins for Dr. Pepper’s North America CSD division rise to 26%, up from our current estimate of 23.4%, there would be a 10% upside to our valuation for the company.

See Our Complete Analysis For Dr Pepper Snapple

Beverage Volumes In The U.S. Could Remain Flat To Negative

Despite growing consumer concerns over the high sugar and calorie content of soft drinks, which has stalled growth in the U.S. CSD market for nine consecutive years, Dr. Pepper has managed to secure steady growth by increasing its market share and improving its operating performance. The domestic CSD market is mature, with Coca-Cola, PepsiCo and Dr. Pepper accounting for almost 90% of the industry-wide volumes. According to our estimates, Dr. Pepper’s market share has risen in each of the last four years, reaching 17.5% last year. According to Wells Fargo, Dr. Pepper’s soft drink volumes and net pricing each grew 0.4% year-over-year in Q3 in measured convenience store channels, buoyed by an overall jump in CSD demand in the retail space during this period. ((This time, CSDs drive industry sales in C-stores, bevnet.com)) We expect net soda volumes for the company to grow only slightly, if at all, in the U.S. this quarter.

Dr. Pepper’s achilles heel in the domestic market has been its underperforming non-carbonated beverage portfolio. While volumes in this segment have grown for both Coca-Cola and PepsiCo, Dr. Pepper’s lack of strong products in the fast growing segments such as organic juices and sports drinks has seen the company’s non-sparkling beverage volumes decline in both Q1 and Q2. Due to lower promotional activities, and the overall slump in juice volumes, as consumer shift away from calorie-fueled beverages, volumes for the juice brand Hawaiian Punch declined 8% and 12% in the first and second quarters respectively. This quarter could entail more of the same for Dr. Pepper’s ailing juice brand.

On the other hand, Snapple volumes also declined last quarter, as Dr. Pepper deprioritized the value line, which typically formed around 10% of the ready-to-drink (RTD) tea brand’s volumes. Tea carries a positive consumer perception as a convenient and healthier hydrant containing antioxidants that boost metabolism. Snapple and Diet Snapple are established products in the RTD tea segment, and together hold a market share of 8% with sales of over $400 million last year. [1] Although volumes could again fall for Snapple this quarter due to lower sales of the value line, a favorable price mix due to higher sales for the premium business could boost the top line. The Snapple premium business increased 1% in the last quarter, and Dr. Pepper looks to leverage the high demand for iced tea to increase Snapple sales, but at the same time push for higher sales of the premium higher priced packs, which contribute more to the margins.

Mexico Volumes And Sales In Focus Amid Increased Taxes

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Despite the soda tax enacted in Mexico at the beginning of the year, Dr. Pepper’s beverage volumes in Latin America rose by 5% in the first half of the year. Mexico, which forms around 90% of the company’s business in Latin America, had imposed a one-peso-per-liter (~8 cents) tax on sugary sodas, effective as of January 1, as the country battles widespread obesity, diabetes, and other health issues. In fact, around 32.8% of Mexico’s population in obese, the highest figure for any country. Around three-fourths of Dr. Pepper’s beverage portfolio in the country is subject to the soda tax. The tax has on an average made soda more expensive by around 8%. 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, an increase in volume sales so far this year reflects high demand for Dr. Pepper’s products, especially the carbonated water brand Penafiel, which grew by an impressive 22% through June.

If Dr. Pepper’s Latin America volumes continue to rise this quarter, revenue-growth could be high in the region, given the higher net pricing. Even though the higher product prices don’t impact the margins, as the company just passes the added tax onto customers, Dr. Pepper’s operating margins rose 180 basis points year-over-year to 14.1% in the first six months, fueled by lower commodity costs and productivity improvements. Profitability could improve again this quarter if volumes remain high, similar to the trend seen in the last two quarters, despite the impact of the soda tax.

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Notes:
  1. Sales of RTD tea brands in the U.S., statista.com []