Dr Pepper Earnings Review: Growth In Both Sparkling And Still Segments Boost Q4 Volume Growth

Dr Pepper Snapple (NYSE:DPS) reported robust sales growth in Q4, on higher than expected beverage sales in the U.S. and Canada, to cap-off a strong 2014. Reported net sales grew 3% year-over-year in the quarter and 2% for the full-year, beating the previously expected revenue growth of only 1%. ^[1] Carbonated soft drinks (CSD) form 80% of the beverage maker’s net volumes, and despite continual headwinds in this segment in the U.S., Dr Pepper managed to grow volumes by 1% in 2014.  The U.S. constitutes almost 90% of the company’s net revenues, and effective net pricing strategies and higher convenience-store and fountain foodservice volumes fueled CSD growth in the past year. On the other hand, while Dr Pepper’s non-carbonated portfolio ended the year with a 1% decline, volume growth was positive in both Q3 and Q4, which could be a sign of growth going forward for this segment.

The third division for Dr Pepper, apart from CSDs in North America and Non-carbonates in North America, is its Latin America business. As expected, sales for this division grew by double-digit percentages, mainly impacted by the sugar tax imposed in Mexico last year. 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-fourths of Dr Pepper’s beverage portfolio in the country is subject to the soda tax. As the company passed this tax onto its customers, retail prices shot up, but despite higher product prices, Dr Pepper’s Latin America volumes were up 5% year-over-year in 2014. Mexico and the Caribbean formed 8.7% of the company’s net revenues last year, up from 8% in 2013. In particular, the carbonated water brand Penafiel has bolstered Mexico sales for the manufacturer, growing by 21% through the year. 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. ^[2]

We have a price estimate of $74 for Dr Pepper Snapple, which is roughly 5% lower than the current market price. However, we are in the process of incorporating the quarterly results into our forecasts and revising our current price estimate.

See Our Complete Analysis For Dr Pepper Snapple

One difference between Dr Pepper’s business and that of Coca-Cola’s and PepsiCo’s is lower exposure to the fluctuations of foreign currency. Negative currency translations (Mexico and Canada) dragged down net revenues by only 1% in 2014 for Dr Pepper, and are expected to be a 1 percentage point headwind again this year. With an improving economic environment in the U.S., customer spending has grown and could continue to boost CSD sales for Dr Pepper in 2015. Apart from achieving a positive sales growth, the company could generate additional cash flow and thereby create value for shareholders this year by expanding margins. Dr Pepper expanded its operating margins by 190 basis points to 19.3% last year, focusing on its Rapid Continuous Improvement (RCI) program.

Dr Pepper’s CSD Sales Remain Strong, But More Opportunities Ahead

CSD sales volumes rose 2% in Q4 and 1% for the full-year, boosting the net sales growth. Dr Pepper, like its peers Coca-Cola and PepsiCo, has been struggling to derive growth from this segment in the domestic market as customers shift away from soft drink consumption on continually growing health concerns. Lower soft drink consumption led the U.S. CSD market to its tenth consecutive year of decline in 2014. But Q4 was a quarter of positive growth for this category, especially as consumer spending improved in the country. The company was also able to increase retail prices of its soft drinks due to the improving economic conditions in the U.S., with falling oil prices and historically low unemployment rates, which boosted customer purchasing power in the country. 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))

However, Dr Pepper ‘s pricing is still lower than its peers. A positive mix is what fueled top line growth for the company last year more than positive pricing. Dr Pepper is also not completely in the smaller packages segment, which has been a growth driver for both Coca-Cola and PepsiCo in terms of higher price per unit in the recent quarters. This means that Dr Pepper has further growth opportunities when it comes to CSDs, and could emphasize more on smaller packages and further raise its product prices to spur revenues, even as volume growth could remain somewhat tepid.

What the beverage maker is doing is trying to ramp-up sales of CSDs by targeting the low/no calorie segment, which has been the Achilles heel for the soft drink category. Dr Pepper had earlier in 2014 announced plans of launching its naturally-sweetened 60 calorie sodas in the domestic market, and is now expanding the test of these naturally-sweetened diet sodas to three key regional markets. Although having six times as many calories as the TEN lineup, Dr Pepper hopes that consumers might prefer naturally-sweetened sugary drinks, which still have less than half the calorie count of regular CSDs (150 calories).

Non-Carbonated Volumes Buoyed By High Snapple Sales

One of the main growth drivers for Dr Pepper’s non-carbonated beverage unit, which forms 25% of the company’s valuation by our estimates, has been the ready-to-drink (RTD) tea brand, Snapple. Overall still beverage volume sales declined in Q2 as Snapple volumes fell, but in Q3 and Q4, the brand’s volumes rose to fuel growth in the overall category. This bodes well for the company as despite de-emphasizing focus on its value line, Snapple volumes have increased. The Snapple premium business grew mid-single-digits in 2014, 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. 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 and 4% in Q4 despite de-prioritizing the value line, which typically formed around 10% of the brand’s net unit sales. Dr Pepper could earn higher net revenues going forward from the tea segment on favorable product mix, due to the company’s focus on the more profitable premium brands. The company is also launching a new line of unsweetened and slightly sweetened teas called Snapple Straight Up Tea, further penetrating the RTD tea segment.

As consumers look to avoid  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 smaller percentages in the subsequent quarters, to end 2014 with a 7% decline in volume sales, limiting the overall decline in juices and subsequently in non-carbonated beverages for the company.

In 2015, while Dr Pepper is expected to somewhat struggle amid continual headwinds in the CSD space, an opportunity to increase retail prices and focus on smaller packages could boost price mix. In addition, the company expects growth in its non-carbonated portfolio, and Snapple will be key to this anticipated growth this year.

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