These Three Scenarios Could Significantly Impact Dr Pepper’s Valuation

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

Dr Pepper Snapple (NYSE:DPS) is the perpetual third behind The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP) in the mature U.S. carbonated soft drinks (CSD) market. However, even as CSDs declined for the 10th consecutive year in the U.S. in 2014, Dr Pepper managed to improve its market share for the fifth year in succession to 17.1%, eating into the volume shares of both Coca-Cola and PepsiCo. [1] Revenue growth for the Texas-based manufacturer was also more than that for its competitors, who suffered due to negative currency translations in foreign markets. Around 88% of Dr Pepper’s net sales came from the U.S. last year, with 4% from Canada, and the rest 8% from Mexico and the Caribbean. This reflects how Dr Pepper is majorly dependent on the domestic market, and given that 80% of its net volume sales are contributed by CSDs, the continuous slowdown in this market has a significant impact on the company’s operations.

We have a price estimate of $78 for Dr Pepper Snapple, which is roughly in line with the current market price.

See Our Complete Analysis For Dr Pepper Snapple

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On the other hand, shifting trends in Latin America, which has been the growth driver for the beverage-maker amid slowing sales in the U.S., could also alter the outlook for Dr Pepper’s business. Here are three scenarios that could have a significant impact on Dr Pepper’s valuation:

Soft drinks can be classified as impulse buys, and the choice to buy a particular product some times boils down to reach and availability. 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 59% volumes of the drink Dr Pepper are distributed by bottlers affiliated with Coca-Cola and PepsiCo. Both these companies constituted approximately half of Dr Pepper’s beverage concentrate sales in 2014.

This means that unlike Coca-Cola and PepsiCo, Dr Pepper doesn’t possess as much control over shipments to ensure optimum store placement, somewhat hampering its reach and availability. Retail shelf space is significant for Dr Pepper, which generated over 12% of its sales last year from Wal-Mart, the world’s largest retail chain. CSDs are already losing shelf space to new high-margin attractive entrants such as energy drinks. Moreover, retailers have been looking to reduce shelf space for the ailing Dr Pepper’s low calorie TEN lineup. Dr Pepper’s direct store delivery (DSD) system could provide shelf inventory management and reduce costs of reordering and merchandising for the retailer, aiming to improve sales and margins for the retailer as well. This could protect the company’s shelf space in retail stores.

A step in this direction was the acquisition of Davis Beverage Group and Davis Bottling Company late last year. Davis distributes a wide range of Dr Pepper’s carbonated and non-carbonated brands, and this acquisition almost doubled Dr Pepper’s distribution in Pennsylvania. Direct store delivery allows the beverage manufacturer to bypass third-party and retailers’ distribution centers. By bringing distribution in-house in parts of Pennsylvania and New Jersey, and through further such acquisitions in future, Dr Pepper could leverage its integrated model to capture downstream margin opportunities.

The biggest impact of in-house distribution will be on average revenue per unit volume for CSDs and non-carbonated beverages (NCB), which could increase to $2.50 and $1.60, respectively, by the end of our forecast period, up from the currently estimated $2.13 and $1.45, respectively. Margins are also expected to witness a rise. Our estimates can be seen, and further tampered with, on the Trefis website. Assuming this scenario, the price estimate for Dr Pepper jumps 20% from our current estimate to nearly $95.

While both Coca-Cola and PepsiCo looked to derive growth from their non-carbonated drinks portfolio in the absence of strong CSD growth, Dr Pepper somewhat struggled to do so. This is because of the absence of strong Dr Pepper brands in some of the fastest growing segments of the non-sparkling beverage category such as energy drinks, sports drinks and bottled water. NCB volume declined 1% for the company in 2014. The division North America Non-Carbonated Drinks forms 25% of the company’s valuation, by our estimates.

Dr Pepper’s own brands such as Hawaiian Punch and Mott’s might be declining, but the beverage-maker could leverage its bottling and/or distribution deals with brands such as Big Red, FIJI mineral water, AriZona tea, Vita Coco coconut water, Bai 5, Neuro beverages, Sparkling Fruit2O and Hydrive energy drinks to grow non-carbonated sales. Coconut water is a budding segment and Vita Coco is the leading brand in this category. On the other hand, bottled water grew volumes by 7.3% year-over-year in 2014, and growing demand in this segment could boost sales of FIJI and Sparkling Fruit2O, in turn adding to Dr Pepper’s sales.

Approximately $741 million (~12% of the net sales) were contributed by distribution of third-party brands last year for Dr Pepper. More partnerships in future, especially as Dr Pepper might also look to boost its distribution network, could improve the share of the company’s NCBs in the U.S. beverage market to nearly 4% by 2021, up from the current estimate where the share is expected to reach 3.2% in 2017 and remain flat thereafter. In this scenario, Dr Pepper’s price estimate jumps 10% from our base estimate of $78.49.

Mexico and the Caribbean formed only 8% of Dr Pepper’s sales last year, but they are the main growth drivers for the company. While sales in the U.S. grew only 1% in 2014, and declined 1% in 2013, Latin America sales rose 15% and 11% in 2014 and 2013, respectively. Growth in revenues for the Mexico business was mainly impacted by the sugar tax imposed in the country last year. Mexico had imposed a one-peso-per-liter (~7 cents) tax on sugary sodas, effective as of January 1 last year, as the country battled widespread obesity, diabetes, and other health issues. As approximately half of the country’s population lives below the poverty line, a rise in product prices, as beverage manufacturers looked to pass-on the tax to customers, could have deterred volume growth. Around three-fourths of Dr Pepper’s beverage portfolio in the country is subject to the soda tax.

However, Dr Pepper’s Latin America volumes were up 5% year-over-year, bolstered by strong growth for the carbonated water brand, Penafiel. The company’s volumes grew in Mexico last year, despite the sugar tax, but this trend could change going forward. Mexico volumes for both Coca-Cola and PepsiCo fell last year, and could fall for Dr Pepper too, given the health issues the country is battling.

Growth might stall in Mexico in the coming years, but it might not have a huge impact on Dr Pepper’s valuation. A fall in Latin America volumes to 300 million gallons by 2021, down from the currently estimated 380 million gallons, coupled with a decline in long-term margins to 10% from the current forecast of 14%, would bring down our price estimate for Dr Pepper by 5%. The Latin America division has a smaller impact on Dr Pepper’s value, as compared to the North America divisions, as it constitutes only 5.4% of the company’s valuation, according to our estimates.

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Notes:
  1. Top 10 CSD brands in the U.S. []