Dr Pepper Snapple Pre-Earnings: Domestic Market Dependence A Positive

Will the perpetual third player behind the behemoths The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP) in the U.S. carbonated soft drinks (CSD) market outperform its much larger competitors in terms of volume growth, yet again?

Dr Pepper Snapple (NYSE:DPS) will release its Q3 results on October 22, and in all probability realize higher top line growth than both Coca-Cola and PepsiCo this quarter. Dr Pepper depends heavily on its CSD portfolio, including the drinks Dr Pepper, Diet Dr Pepper, 7UP, Canada Dry, Sunkist Soda, A&W, etc., which constitute approximately 80% of the net volume sales for the company. And considering that the U.S. accounts for ~90% of the net sales for the beverage manufacturer, performance of Dr Pepper in the U.S. CSDs is crucial to our analysis.

We have a price estimate of $81 for Dr Pepper Snapple, which is below the current market price.

See Our Complete Analysis For Dr Pepper Snapple

Dr Pepper Has Managed To Grow In A Soft Domestic CSD Market

A couple of reasons support why Dr Pepper is expected to outpace growth in sales seen by both Coca-Cola and PepsiCo. Firstly, the Texas-based manufacturer has room to grow — in terms of both volumes and pricing.

Dr Pepper’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 is 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, Dr Pepper has slowly but surely achieved market share growth in this space, which is dominated by Coca-Cola and PepsiCo with a combined volume share of 70%, through increased reach and availability.

RCI lean tracks have 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. In Q3, too, the company is expected to witness a rise in consumption due to increased reach and availability, buoyed by stronger economic conditions in the domestic market.

The other reason why Dr Pepper could grow more is because of its relatively less exposure to overseas markets. 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 both Coca-Cola and PepsiCo, both of which expect unfavorable foreign exchange to drag down their respective full-year revenues by high single-digit percentages. In fact, PepsiCo reported a 12 percentage point currency headwind on the top line in Q3. While roughly 10% of Dr Pepper’s net sales come from Mexico and the Caribbean and Canada — which are all the foreign markets the company operates in, Coca-Cola and PepsiCo derive roughly half of their sales from markets outside the U.S.

Sustained low gas prices have boosted customer spending and allowed beverage companies to operate at higher price points. The U.S. GDP expanded at a solid 3.9% last quarter, which reflects stronger economic conditions. Favorable price and package mix should also boost Dr Pepper’s top line this quarter.

Still Beverages To Lead Growth This Quarter

20% of Dr Pepper’s volume sales are constituted by still beverages, but this segment is the one presenting the most growth opportunities. As customers continue to ditch calorie-fueled sodas, volume sales of other segments such as bottled water, energy drinks, sports drinks, ready-to-drink teas and coffees, etc. have been rising. Seeing customers transition, beverage companies have also had to increase their focus on these other drink categories. While CSD unit sales grew 2% year-over-year through the first half of the year, still beverage volume grew 4% for Dr Pepper. The non-sparkling lineup is expected to yet again drive volume growth this quarter on the back of strong growth for the likes of the tea brand Snapple, which grew 8% in the first half partially driven by product innovation, bottled water brands Bai5 and Fiji, and even the juice brand Hawaiian Punch, which has grown this year after consecutive quarters of decline since 2014.

Expect a solid core performance in still beverages, and with the domestic economy holding strong, even CSDs could contribute to strong growth this quarter. Currency headwinds are bound to drag down the top line and EPS due to the continually stronger U.S. dollar, but this impact shouldn’t be profound since Dr Pepper is earning most of its revenues in the home currency to begin with.

See the links below for more information and analysis:

• PepsiCo earnings review: core performance remains strong, although marred by structural changes
• Bottled water is a potential growth category that can’t be ignored
• Soda makers wonder: where could growth in U.S. come from?
• The strong dollar is weighing down these large beverage companies
• Trefis analysis: Dr Pepper North America CSD Revenues
• Trefis analysis: PepsiCo Soft Drink Revenues
• Trefis analysis: Coca-Cola Revenues

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