Dr Pepper Earnings Review: Solid Growth Across Carbonated And Non-Carbonated Segments

Dr Pepper Snapple (NYSE:DPS) reported better than expected Q1 results on April 23, with net sales up 4% year-over-year to $1.45 billion, and 4% growth in earnings per share. ^[1] A solid start to 2015 sets the tone for the rest of the year for Dr Pepper, which derives slightly less than 90% of its net sales from the U.S. alone, and has benefited from the improving economic environment in the country. The rest of the sales for the Texas-based company come from Canada, Mexico, and the Caribbean, and the strengthening U.S. dollar against the Canadian dollar and Mexican peso dragged down the top line by 1% this quarter. However, the impact of negative currency translations on Dr Pepper’s financials was much less than that for its chief competitors, The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP), that are more exposed to the risk of foreign currency depreciation.

We have a price estimate of $78 for Dr Pepper Snapple, which is roughly in line with the current market price. However, we are currently in the process of incorporating the recent quarterly results into our forecasts, and revising our price estimate.

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Apart from strong growth in the domestic market, Dr Pepper’s Latin America business also continued to grow in Q1, on strong performances by the carbonated water brand Penafiel, and other carbonated soft drinks (CSD). Ongoing productivity improvements and a planned reduction in marketing investments resulted in a 7% increase in segment operating profit, and the company’s rapid continuous improvement (RCI) program also continued to drive both top line and bottom line growth.

In addition, Dr Pepper’s focus on direct store delivery, which allows the beverage manufacturer to bypass third-party and retailers’ distribution centers, could further boost margins. By bringing distribution in-house, Dr Pepper could leverage its integrated model to capture downstream margin opportunities. As around 59% of volumes of the drink Dr Pepper are distributed by bottlers affiliated with 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. Dr Pepper’s direct store delivery (DSD) system could provide shelf inventory management and reduce costs of re-ordering 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.

Strong Growth In CSDs In North America

CSD volumes grew 3% for Dr Pepper in Q1, and net volumes rose 2% in the U.S., outperforming both Coca-Cola and PepsiCo’s volume growths. Dr Pepper is hugely dependent on its domestic market, and a strengthening economic environment in the country, with improving customer purchasing power due to low oil prices and a jobless rate under 6%, have resulted in higher sales for the company this quarter. In 2014 as well, when the U.S. CSD market declined for the tenth consecutive year, Dr Pepper was able to increase its market share on flat year-over-year volume growth, while both Coca-Cola and PepsiCo’s CSD volumes and market shares fell. In fact, the staple Dr Pepper drink grew volumes by 0.5%, outperforming both Coke and Pepsi-Cola, and consolidating its position as the fifth-highest-selling soft drink in the U.S. ^[2] As approximately 80% of Dr Pepper’s net volume is CSDs and most of the sales are from the domestic market, a rise in U.S. soft drink sales lifted the overall results for the company.

Apart from being able to achieve volume growth in an otherwise mature U.S. CSD market, Dr Pepper was able to further boost its top line through positive mix. The consumer-price index for nonalcoholic beverages grew in each of the months through December-February. ^[3] A positive segment mix, i.e. higher proportionate sales of finished goods cases compared to concentrate cases, rose net sales by 1.5% in Q1, while product mix increased net sales by over 1%. Improved economic conditions in the U.S. have allowed Dr Pepper to raise its retail prices, and combined price and mix could grow by about 2% this year for the company. ^[4] There is even more opportunity for Dr Pepper to boost its revenue growth, as the company’s pricing is still lower than its peers. A positive mix is what fueled top line growth for the company more than positive pricing. Dr Pepper is 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.

Non-Carbonated Beverages Grow By 5% In Q1

While both Coca-Cola and PepsiCo have looked to derive growth from their non-carbonated drinks portfolio in the absence of strong CSD growth, Dr Pepper had somewhat struggled to do so in the past, 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. However, the non-carbonated segment grew by an impressive 5% this quarter, on the back of strong sales for the ready-to-drink tea brand Snapple, and Hawaiian Punch, which returned to growth in Q1 (~7% volume rise), following consecutive quarters of decline.

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. Dr Pepper’s overall still beverage volume sales declined last year as Snapple volumes fell in the early part of the year, as the company de-prioritized the value line, which typically formed around 10% of the brand’s net unit sales. However, Snapple’s volumes rose to fuel growth in the overall category in Q3 and Q4 last year, and continued its growth momentum in Q1 this year, rising by 5% year-over-year. This bodes well for the company as despite de-emphasizing focus on its value line, Snapple volumes have increased. The Snapple premium business grew by a high-single-digit in Q1, 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. Higher proportionate sales of bottled water this quarter, which grew by 9%, dragged down gross margins. By leveraging the high demand for tea and Snapple’s strong brand recognition, Dr Pepper could continue to increase volumes. The company also launched a new line of unsweetened and slightly sweetened teas called Snapple Straight Up Tea, further penetrating the RTD tea segment this year.

Dr Pepper could continue to earn higher net revenues from the tea segment on favorable product mix, due to the company’s focus on the more profitable premium brands. Effective product pricing, aided by the strong economic environment in the U.S., is expected to drive top line growth in the next few quarters.

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1. Dr Pepper 10-q [↩]
2. U.S. beverage business results for 2014 [↩]
3. Consumer Price Index- March 2015 [↩]
4. Dr Pepper earnings transcript [↩]