The Week That Was: Beverage Stocks

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

This week we will discuss the new figures made available by research firms Beverage-Digest and Beverage Marketing Corporation, which will help us understand the trends in the U.S. liquid refreshment beverage market better. The Coca-Cola Company (NYSE:KO), PepsiCo (NYSE:PEP) and Dr Pepper Snapple (NYSE:DPS) continue to witness headwinds in the ailing carbonated soft drink (CSD) segment, as is also clear from the recently released figures. As expected, the diet variants continue to underperform the overall CSD category.

However, the silver lining for these beverage companies is that while the core soda business, which still forms a majority of the U.S. beverage industry, continues to decline, the improving economic conditions in the U.S., and higher customer purchasing power, have boosted the non-carbonated beverage category. Ready-to-drink (RTD) tea and coffee, sports drinks, and energy drinks, witnessed strong volume growth in 2014. Growing popularity of these budding segments presents growth opportunities to Coca-Cola, PepsiCo, and Dr Pepper going forward.

Biggest Winner — The Dr Pepper stock growth continues to beat growth in Coca-Cola and PepsiCo stocks, with the former’s stock jumping 3% this week, compared to the increase of 0.7% and 1.3% for the Coca-Cola and PepsiCo stocks. All three stocks performed better than the overall S&P 500 Index this week.

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Coca-Cola

The good news for the U.S. CSD market, and for its largest contributor Coca-Cola, is that volume sales declined only 1% year-over-year in 2014, following the 3.1% decline in 2013. Improving economic conditions in the U.S. and higher customer purchasing power, owing to falling oil prices and historically-low unemployment rates, have bolstered sales of soft drinks as well. A lower-than-expected fall in CSD volumes, coupled with successful pricing strategies, could restore revenue growth in this category going forward. Coca-Cola has emphasized sales of smaller packs, which have lower cumulative calories and higher unit pricing — a win-win for both the health activists, who are pushing for lower calorie consumption, and Coca-Cola, which is benefiting from the higher average revenue per unit volume of the smaller cans and bottles.

We estimate a $41 stock price for Coca-Cola, which is slightly above the current market price.

See our full analysis for Coca-Cola

Now for the bad news. After years of holding the second place behind the trademark cola-drink Coca-Cola, Diet Coke slid to the third spot behind Pepsi in 2014. This was due to a 6.6% fall in volume sales year-over-year for Diet Coke, more than the 5% fall for Diet Pepsi. Customers are wary of diet/low-calorie products as they use artificial sweeteners, such as aspartame, which are considered unsafe. Coca-Cola launched its Stevia-drink Coke Life in the U.S., U.K., and Mexico last year, and will hope that customers come back to the diet category, as Stevia is a natural sweetener and holds a positive customer perception.

PepsiCo

Pepsi jumped to the second largest soft drink spot in the U.S. in 2014, which however, by no means was a positive year for the company’s namesake brand. Volume sales for the trademark Pepsi declined 3% last year. But the flavored soda, Mountain Dew, grew 1.5% last year, which is a bright spot for the company. PepsiCo has for some time now fended-off activist investors who are pushing to spin-off the ailing beverage business, in a bid to allow the snacks business to unlock its true potential. However, the management remains committed to deriving synergies between the food and beverage divisions. Apart from the cost-benefits and increasing shareholder return that PepsiCo needs to appease its investors, one would think that the company also needs its core CSD business to turn a new leaf sometime soon, and add to the top line growth.

We estimate a $102 price for PepsiCo, which is above the current market price.

See Our Complete Analysis For PepsiCo

Mountain Dew’s growth is a shot in the arm in this respect, and PepsiCo will look to continue to spend behind its brands and hope to boost demand. In fact, the company is also looking to come out with a Doritos-flavored Mountain Dew. Apart from CSDs, two other major beverage brands for PepsiCo — Gatorade (sports drink) and Aquafina (bottled water), witnessed robust growths of 3.7% and 7.4% respectively in 2014, mainly as the demand for sports drinks and bottled water remained strong.

Dr Pepper Snapple

Dr Pepper doesn’t have many strong brands in the non-carbonated segments such as sports drinks, energy drinks, and bottled water. However, the company does have a strong 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 a focus on its value line, which typically formed around 10% of the brand’s net unit sales, Snapple volumes have increased. The Snapple premium business grew mid-single-digits in 2014, boosting the top line.

We have a price estimate of $78 for Dr Pepper Snapple, which is lower than the current market price.

See Our Complete Analysis For Dr Pepper Snapple

RTD tea is a segment of the U.S. beverage industry that is growing at a fast pace, due to a healthier, more natural perception. Volume sales grew by 3.7% in this segment in 2014, which bodes well for Snapple — the third largest RTD tea brand in the country, after Arizona and Lipton. Dr Pepper could continue to leverage the high demand for RTD tea in the U.S. to grow volume sales, and also improve profitability due to a higher emphasis on the premium line, in a bid to boost its non-carbonated beverage unit, which forms 25% of the company’s valuation, by our estimates.

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