Dr. Pepper Snapple Follows Coca-Cola Into The At-Home Carbonation Market

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

In the last year, Dr Pepper Snapple‘s (NYSE:DPS) stock has jumped by over 50% due to a strengthening beverage business, despite headwinds in some of the core categories. Nearly 70% of the Texas based beverage maker’s valuation comes from the North America carbonated soft drinks (CSD) division, according to our estimates. Net volume sales for Dr. Pepper remained flat through the first three quarters, hurt by 1% declines in both U.S. and Canadian volumes. However, the company’s top line expanded nearly 3% in Q3, and 2% year-to-date, on higher unit pricing, prompting the company to raise its full-year sales outlook to 1% growth, up from the previously estimated flat to negligibly small increase. [1] The impact of the stagnating U.S. beverage market, and especially the CSD segment, is affecting more Dr. Pepper, as compared to  chief competitors Coca-Cola and PepsiCo, which derive half or more of their annual revenues from outside of the U.S. However, Dr. Pepper has proved itself as a worthy competitor in the domestic market, gaining market share in the CSD segment in each of the last five years.

Moreover, the company’s non-carbonated (or still) portfolio also finally rebounded to growth in Q3, after declines of 2% and 4% in the first and second quarters respectively. This was buoyed by strong growth in the water portfolio and ready-to-drink (RTD) teas, especially Snapple. Dr. Pepper has gained from higher net pricing of its sodas as well as the premiumization of its popular Snapple tea brand. Despite only a modest growth in the top line, Dr. Pepper has managed to boost its cash flow and return to shareholders by leveraging its integrated model and improving operational efficiencies. Operating margins through Q3 rose to 20%, up from 17.25% in the first three quarters of 2013. Just for comparison, Coca-Cola and PepsiCo’s margins during the same period stood at 23.5% and 16% respectively.

Seeing how Dr. Pepper has been able to squeeze-out higher profits through higher productivity savings, lower commodity costs, and despite flat volume sales growths in the U.S. and Canada, we are revising our price estimate upward for the company. We now have a price estimate of $74 for Dr Pepper Snapple, which is roughly in line with the current market price.

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See Our Complete Analysis For Dr Pepper Snapple

Dr. Pepper-Keurig Deal

A new development for Dr. Pepper that could spur sales by increasing reach and availability of the company’s beverage brands, is the deal with Keurig Green Mountain (NASDAQ:GMCR), which makes novelty coffee and owns Keurig brewers, and is coming out with its at-home carbonation system called the Keurig Cold Machine by the Fall of this year. [2] Last year, Coca-Cola bought a 10% stake in Keurig Green Mountain, and raised it to 16% in May. Coca-Cola, and now Dr. Pepper, will look to introduce some of their beverage offerings with the Keurig Cold Machine later this year, and hope to improve falling soda consumption rates. At-home carbonation has emerged as an additional platform for soft drink consumption. This market might not be able to bring back consumers to CSDs, but due to the ease of carrying compact flavor sachets and the convenience of in-house consumption, the intake rate of avid customers could increase. Last year, SodaStream, a maker of at-home carbonation systems, estimated that the global market for at-home beverage systems has the potential to grow to $260 billion, while the market in the U.S. could generate a cumulative $40 billion. [3] This estimate uses the aggressive assumption that these systems will penetrate about 87% of the domestic households. However, even if around 30% of the domestic households purchase at-home beverage systems, the U.S. market could grow to $14 billion.

The multi-year Dr. Pepper-Keurig deal appoints the latter as the exclusive producer of single-serve, pod-based CSD Dr. Pepper brands that use fountain syrup in the Keurig Cold platform in the U.S. and Canada. We had estimated earlier how following the Coca-Cola-Keurig agreement, Dr. Pepper might also look to join forces with either Keurig, SodaStream or Bevyz in order to enter the at-home carbonation space. In 2013, Dr. Pepper partnered with Keurig Green Mountain to sell Snapple premium iced teas in K-Cups and Vue packs compatible with Keurig single cup brewing systems. The extended partnership between the two companies will now provide an additional consumption platform for select Dr. Pepper brands and could possibly raise sales.

Higher Reach And Availability Could Boost Sales

Concentrates for both Coca-Cola and PepsiCo are largely bottled by the companies themselves. This means that the beverage giants control bottling operations and consequently direct store delivery systems, ensuring top-shelf positioning of their beverages in convenience stores. In contrast, around 63% of volumes of the drink Dr. Pepper are distributed by bottlers affiliated with Coca-Cola and PepsiCo. Both these companies constituted nearly half of Dr. Pepper’s beverage concentrate sales in 2013. This means that unlike Coca-Cola and PepsiCo, Dr. Pepper doesn’t posses as much control over shipments to ensure optimum store and shelf placement, somewhat hampering its reach and availability. As most of the beverage purchases are impulse buys, proximity to the end consumer is crucial. By partnering with Keurig, Dr. Pepper will enter the at-home carbonation market, and could also see a rise in sales of concentrates, given Keurig’s extensive reach and strong customer base in the U.S.

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Notes:
  1. Dr. Pepper Snapple 10-q []
  2. Dr. Pepper Snapple press release []
  3. PepsiCo enters at-home carbonation market before Coca-Cola and Keurig Green Mountain“, March 2014, fool.com []