Riding On Domestic Growth, Dr Pepper’s First Half Has Been Solid

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

Dr Pepper Snapple (NYSE:DPS) has ended the first half of 2015 with solid growth across both its carbonated soft drinks (CSD) and non-carbonated drinks portfolios. The Texas-based manufacturer reported earnings on July 23, posting a 1% year-over-year rise in CSD bottler case volumes in Q2. Now, for anyone who has been following the trends in North America CSDs, 1% volume growth does sound solid. Sodas form around 80% of Dr Pepper’s net volumes, and the U.S. accounts for ~90% of the net sales, which is why the performance of Dr Pepper in U.S. CSDs is crucial to our analysis.

We have a price estimate of $80 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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The strengthening dollar has been a downer for U.S. multinationals in recent times, and also impacted Dr Pepper’s financials in Q2, pulling down net sales by 2 percentage points (net sales rose by 1.5%). However, the stronger domestic currency isn’t as big a problem for Dr Pepper as it is for The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP), both of which expect unfavorable foreign exchange to drag down their respective full-year revenues by high single-digit percentages. Dr Pepper is growing by more than its compatriots– not just because of its relatively less exposure to international markets that remain volatile, but also due to its stronger growth in the domestic market.

topline growth in Q2

Dr Pepper Has More Room To Grow In U.S. CSDs

The U.S. CSD market has declined for ten consecutive years now as customers move away from the calorie-fueled sugary sodas to healthier alternatives. But, it’s still the most voluminous category, constituting 41% of the net volumes in the country’s liquid refreshment beverage market, according to our estimates. This market might be relatively mature, and dominated by Coca-Cola and PepsiCo, who command a combined volume share of 70%, but Dr Pepper has slowly but surely achieved market share growth in this space through increased reach and availability.

volume share in U.S. CSD market

The company’s Rapid Continuous Improvement (RCI) continues to drive both top line expansion and productivity across all operations. Considering that soft drinks are typically impulse buys, and most of the top companies are generally well-regarded by customers, volume sales become a function of reach and availability–where Dr Pepper lags both Coca-Cola and PepsiCo. 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.

However, now with more focus on direct store delivery, which allows the beverage manufacturer to bypass third-party and retailers’ distribution centers, Dr Pepper could further improve its visibility, and, in fact, also boost margins. By bringing distribution in-house, the company could leverage its integrated model to capture downstream margin opportunities. RCI lean tracks have also helped in improving single serve distributions. Dr Pepper added 17,000 new fountain valves across both local accounts and national accounts, and saw fountain foodservice volumes rise 4% during Q2. More distribution, coupled with a rise in marketing expenditure (7.6% of net sales), is why Dr Pepper’s visibility has increased, and, in turn, propelled growth in volume sales.

The brand Dr Pepper grew 1% in the quarter, boosted by the conducive market conditions in the U.S., more distribution, and strategic investments by the company. Another win for Dr Pepper in Q2 was the diminished rate of decline for Diet Dr Pepper, which declined by 3%. It’s not that the company, or even the diet soda market, have figured out the solution to the almost free-falling sales of low/no calorie sodas, but Dr Pepper believes that a combination of diet, mid-calorie, and naturally-sweetened products might help reverse the trend– and the company is present in all three spaces (the naturally-sweetened sodas are in select test markets for now).

Apart from volume growth, Dr Pepper has more room to grow in terms of its net pricing. The company’s price mix is still lower than that of Coca-Cola and PepsiCo, both of which have gained from the introduction of several smaller packages, which have higher prices per unit. Although Dr Pepper believes that the added complexity of introducing a plethora of pack sizes might not be right for its current operating model, the company is definitely moving in that direction. For example- while Coca-Cola’s sparkling volume rose 1% in North America, transactions rose 2% in Q2–this means more proportionate sales of smaller packages. This helped the company achieve 4 percentage points of effective net pricing. On the other hand, the underlying pricing growth added around 1% to Dr Pepper’s CSD business in the quarter. Dr Pepper might be late to arrive at the party, but if and when it does, it will have more room to grow. And considering that the company is already growing by more than its almost-omnipresent competitors, this puts the company in a good position.

Dr Pepper’s top line grew 3% in Q2 in organic terms, and this includes growth in volumes as well as net pricing in CSDs. The company still has much less share in the market compared to its much larger compatriots, and higher distribution and more visibility could further unlock the growth potential for Dr Pepper in the U.S.

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