Dr Pepper Expected To End 2015 On A High With Strong Sales In The Home Market

DPS: Dr Pepper Snapple logo
DPS
Dr Pepper Snapple

Dr Pepper Snapple (NYSE:DPS) is scheduled to announce its Q4 and full year results on February 17, and we expect the beverage manufacturer to cap off 2015 with solid growth, especially as most of its sales are from the home market. [1] Both Coca-Cola and PepsiCo have already announced their full-year results, which suggest that while macroeconomic volatility in international markets, with subdued demand and depreciating local currencies, continued to drag down financials, strong growth in North America, particularly in the U.S., helped to boost overall results. As crucial international markets such as Russia, Brazil, and China slowed down during 2015, companies looked towards the home market for growth. This bodes well for Dr Pepper, which generates approximately 90% of its net sales from the U.S. The company is, thus, less exposed to the risk associated with currency fluctuations — which turned out to be one of the bigger culprits depressing results for America-based multinationals last year.

Dr Pepper’s stock has grown by 20% in the last 52 weeks, more than the 3% growth for Coke’s stock and 1% decline for PepsiCo’s stock. Investor confidence could further be strengthened after the announcement of the full-year results. The company could be poised to beat consensus estimates on its EPS growth, as it is seeing favorable earnings estimate revision activity just before the announcement.

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Around 80% of Dr Pepper’s volume is in carbonated soft drinks (CSD). As CSDs continue to bear the brunt of growing health concerns and customer skepticism regarding the usage of artificial sweeteners and/or bitter aftertastes of the diet/low calorie drinks, there has been a continual segment shift from carbonated to certain non-carbonated segments such as sports drinks, ready-to-drink teas, and bottled water, which carry healthier customer perceptions. However, Dr Pepper has managed to grow amid these headwinds, with its branded CSD volume increasing 2% year-over-year in the nine months to September. This trend could have continued into the fourth quarter, especially as both Coca-Cola and PepsiCo have also reported volume growth in North America, driven by the positive economic environment.

Gasoline prices have dropped by over 50% in the last 18 months, giving extra cash to customers, which has, in turn, boosted spending in convenience stores. [2] According to PepsiCo, U.S. convenience store sales were up 6% in 2015. Higher customer traffic at convenience stores is also expected to have boosted Dr Pepper’s volume sales this quarter.

Non-Carbonated Beverages To Be The Growth Driver

While CSD unit sales grew 2% year-over-year through the first nine months of 2015, still beverage volume grew 4% for Dr Pepper. 20% of Dr Pepper’s volume sales are constituted by still beverages, but this segment is the one presenting the most growth opportunities.

A high growth category for Dr Pepper is RTD tea, which although forms only 4% of the U.S. beverage industry as of now, is expected to grow at a CAGR of 5% at constant 2014 prices, to reach sales of $6.6 billion by 2019. [3] In comparison, CSD volume sales are expected to remain flat or grow by less than 1%, at best. The Pepsi-Lipton Tea Partnership led the RTD tea segment in off-trade value terms in 2014, with a share of 25%, followed by AriZona Beverage Company, which has a share of 24%. Dr Pepper’s Snapple tea brand ranks third in this segment, and has been growing at a brisk pace.

What’s working well for the company is that the Snapple brand is accretive to the overall margins due to the increased focus on premiumization of this brand. Snapple volumes fell in the early part of 2014, 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 in Q3 and Q4 2014, and continued to grow through Q3 2015, rising by 7% year-over-year. This bodes well for the company, as despite de-emphasizing the focus on its value line, Snapple volumes have increased.

In addition, growth in allied brands which have distribution agreements with Dr Pepper bodes well for the company’s future. The allied brands growth is included in the packaged beverage volumes for Dr Pepper, which is the distribution wing for these small, but fast growing brands, such as Bai 5, Vita Coco, etc. At the gross margin line, the allied brands tend to carry lower gross margin because they have somebody else’s manufacturing profit in there, but are good contributors to Dr Pepper’s operating profitability. Allied brands form a small proportion of net volumes at present, but are an important factor of growth.

On the back of solid growth expected in the home market, which forms a bulk of Dr Pepper’s sales, we expect the Texas-based manufacturer to register strong growth across both the sparkling and non-sparkling divisions.

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Notes:
  1. Dr Pepper Snapple press release []
  2. Coca-Cola, PepsiCo thirst for oil dividend, wsj.com []
  3. RTD tea in the U.S., euromonitor.com []