Dr. Pepper’s Non-Carbonated Volumes Rebound To Boost Q3 Results

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

Dr Pepper Snapple (NYSE:DPS) reported third quarter results on October 23, reflecting strength in its beverage business, despite headwinds in some of the core categories. Consumers continue to shift away from sugar-fueled beverages such as carbonated drinks and juices, and as a result, volumes for Dr. Pepper’s offerings in these categories also fell. However, Dr. Pepper’s top line expanded nearly 3% this quarter and 2% year-to-date, prompting the company to raise its full-year sales outlook to 1% growth, up from the previously estimated flat to negligibly small increase. [1] A deviation from previous quarters was growth in still beverage volumes, after declines of 2% and 4% in the first and second quarters respectively. This was buoyed by strong growths in the water portfolio and ready-to-drink (RTD) teas.

As expected, Dr. Pepper’s Latin America volumes, which typically form just under 10% of the net volumes, seem to be unaffected by the soda tax enacted in January in Mexico. After increasing 2% and 6% in the first two quarters respectively, Latin America volumes rose by an impressive 10% in Q3 for the company. With volumes remaining flat in both the U.S. and Canada, high volume growth in Mexico and the Caribbean along with higher net pricing boosted the top line in Q3, and could again drive top line growth next quarter.

We have a price estimate of $64.92 for Dr Pepper Snapple, which is around 3% lower than the current market price.

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See Our Complete Analysis For Dr Pepper Snapple

Non-Carbonated Volumes Rise To Fuel Growth In North America

As consumers look to avoid the sugar and calorie-fueled carbonated drinks, volumes for healthier non-carbonated beverage segments such as sports drinks, bottled water, natural juices and RTD tea have been rising. Growth in still beverages has bolstered overall volume growth for companies, amid declines in carbonates. However, while still beverage volumes for rival companies Coca-Cola and PepsiCo remained strong, Dr. Pepper’s still beverages declined in both Q1 and Q2. This decline in non-sparkling sales was mainly as volumes for the company’s juice brand, Hawaiian Punch fell 8% and 12% in the first and second quarters, as consumers continued to shift from high-calorie juices to organic all-natural and healthier beverages, and also due to lower promotional activities centered on the juice brand. However, Hawaiian Punch volumes fell by only 2% this quarter, limiting the overall decline in juices and subsequently in non-carbonated beverages for the company.

One of the main growth drivers for Dr. Pepper’s non-carbonated beverage unit, which forms 27% of the company’s valuation by our estimates, has been the RTD tea brand Snapple. Overall still beverage volume sales declined last quarter as Snapple volumes fell, but this quarter, the brand’s volumes rose to fuel growth in the overall category. This bodes well for the company as despite de-emphasising focus on its value line, Snapple volumes have increased. The Snapple premium business grew mid-single-digits in Q3, boosting the top line. Just like flavored bottled water, RTD tea is also a segment of the U.S. beverage industry that is growing at a fast pace, due to a healthier more natural perception. But unlike in bottled water, where margins are thinner, RTD tea, and in particular the premium products, are more profitable.

Snapple and Diet Snapple are established products in the RTD tea segment, and together hold a market share of 8% in this segment in the U.S., with sales of over $400 million last year. [2] By leveraging the high demand for tea and Snapple’s strong brand recognition, Dr. Pepper could continue to increase volumes. Snapple volumes rose 2% in Q3 despite deprioritizing the value line, which typically formed around 10% of the brand’s net unit sales. If volumes remain strong again in the next quarter, Dr. Pepper could earn higher net revenues from the tea segment on favorable product mix, due to the company’s focus on the more profitable premium brands.

Mexico Volumes Register Double-Digit Growth Despite The Soda Tax

The impact of the soda tax imposed in Mexico at the start of the year seems to be milder on Dr. Pepper than its competitors. While Coca-Cola’s volumes fell in Mexico in the first half of the year and rose by only 1% in Q3, Dr. Pepper’s Latin America volumes, which mainly constitute Mexico, rose 6% in the first nine months. According to our estimates, Dr. Pepper sells roughly one-tenth the volumes sold by Coca-Cola in Mexico. By outpacing the volume growth of its chief competitor, the Texas-based manufacturer is set to improve its market share in the country this year.

Mexico 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. Approximately 32.8% of Mexico’s population is 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, some price-sensitive customers were dissuaded from soft drink consumption, which saw volumes of soda brands such as Squirt and Crush fall through September.

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 25% in Q3 and 23% through September. Mexico’s drive for healthier beverages could see more and more consumers shift to segments such as sparkling water, which even in the U.S. is touted as a possible threat to carbonated soft drink sales. Now Dr. Pepper is expanding its Penafiel line in the U.S., gauging the possible demand for the product within the Hispanic population. [3] The Hispanic population in the U.S. is expected to grow by 12% between 2015-2020 to form nearly 20% of the country’s net population, which is estimated to grow by only 4% during this period. [4] Penafiel and consequently Dr. Pepper could expand into the fast growing U.S. carbonated bottled water market, which is worth around $1.25 billion at present but has grown by double-digit percentages in the last couple of years, and gather additional volume sales. [5]

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Notes:
  1. Dr. Pepper Snapple 10-q []
  2. Sales of RTD tea brands in the U.S., statista.com []
  3. Dr. Pepper Snapple earnings transcript []
  4. U.S. demographic projections []
  5. Sales of sparkling bottled water brands, statista.com []