Dr Pepper Pre-Earnings: Effective Net Pricing In The U.S. To Fuel Top Line Growth In Q4

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

Dr Pepper Snapple (NYSE:DPS) is scheduled to announce its Q4 and full-year results on February 12. As compared to its chief competitors Coca-Cola and PepsiCo, the company might report a more robust business growth in the quarter. This is mainly as Dr Pepper derives approximately 90% of its revenues from the U.S. and operates only in the U.S., Canada, Mexico, and the Caribbean. On the other hand, both Coca-Cola and PepsiCo draw nearly half their revenues from outside the domestic market. While increased volatility in some of the key emerging markets dragged down revenues for both these beverage giants in 2014, Dr Pepper’s sales are not as susceptible to currency fluctuations in major developing markets, except for Mexico. The company is expected to gain from an improving economic environment and higher customer spending in the U.S. this quarter.

In the last 52 weeks, Dr Pepper’s stock has jumped by over 60% 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] A further improvement in net pricing in Q4 is expected to boost Dr Pepper’s top line growth.

We have a price estimate of $74 for Dr Pepper Snapple, which is roughly 5% lower than the current market price.

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See Our Complete Analysis For Dr Pepper Snapple

 

Higher Unit Pricing In The U.S. To Fuel Sales Growth

As consumers continue to shift away from sugar and calorie-fueled soft drinks, the U.S. CSD market declined for the tenth consecutive year last year. As Dr Pepper depends heavily on domestic demand, a stagnating market and dominance of Coca-Cola and PepsiCo in this segment, typically signal a bleak future for the company. However, Dr Pepper has managed to achieve top line growth in this segment, by emphasizing on a positive price mix, and could witness growth again this quarter. In addition, the manufacturer 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. Just for reference, PepsiCo’s share has declined over this period.

Improving economic conditions in the U.S., with falling oil prices and historically low unemployment rates, have boosted customer purchasing power in the country. As a result, beverage makers have been able to raise their product prices. According to Citi Research, the consumer-price index for nonalcoholic beverages grew in each of the months through September-December, after remaining flat for two years. Despite tepid volume sales, CSD sales in the U.S. increased 1.2% year-over-year in the twelve weeks ended December 28, mainly on a 3.8% rise in prices during the same period. ((Coke, Pepsi feeling drained overseas, wsj.com)) Higher retail prices this quarter are expected to boost Dr Pepper’s top line growth.

A reference here could be Coca-Cola and PepsiCo’s Q4 results. Coca-Cola’s currency neutral North America revenues (excluding structural changes) expanded 5% year-over-year in the fourth quarter, mainly on a price/mix increase of 4%. [2] On the other hand, organic revenues for the PepsiCo Americas Beverages division rose 3%, on the back of a 2.5% impact of effective net pricing. [3]

Revenues To Be Impacted By The Mexican Sugar Tax

The impact of the soda tax imposed in Mexico at the start of 2014 could again be milder on Dr Pepper than its competitors. While Coca-Cola’s volumes fell in Mexico in the first half of the year, rose by only 1% in Q3, and declined again in Q4, Dr Pepper’s Latin America volumes, which mainly constitute Mexico, rose 6% in the first nine months of last year. 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 have improved its market share in the country in 2014.

Mexico had imposed a one-peso-per-liter (~8 cents) tax on sugary sodas, effective as of January 1 last year, as the country battled widespread obesity, diabetes, and other health issues. Approximately 32.8% of Mexico’s population is obese, the highest figure for any country. Around three-fourth of Dr Pepper’s beverage portfolio in the country is subject to the soda tax. The tax has on 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 in Mexico through September reflects high demand for Dr Pepper’s products, especially the carbonated water brand Penafiel, which grew by an impressive 25% in Q3 and 23% year-to-date. 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. [4] 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. [5] Penafiel and consequently Dr Pepper could expand into the fast growing U.S. carbonated bottled water market, which is worth over $1.25 billion at present, but grew by double-digit percentages during 2012-2013, and gather additional volume sales. [6]

While volume growth might remain limited for Dr Pepper due to continually lower customer demand in the U.S. and Canada, and the negative impact of the sugar tax in Mexico, we expect the company to report positive top line growth this quarter and for the full-year, on higher unit pricing in both the U.S. and Mexico.

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Notes:
  1. Dr Pepper Snapple 10-q []
  2. Coca-Cola 8-k []
  3. PepsiCo 8-k []
  4. Dr Pepper Snapple earnings transcript []
  5. U.S. demographic projections []
  6. Sales of sparkling bottled water brands, statista.com []