Dr Pepper Snapple (NYSE:DPS) announced its Q1 earnings on Wednesday. Net revenues for the quarter stood at $1.36 billion, up 2% year-over-year. However, net income dropped to $102 million primarily because of negative impact of higher cost of sales. Total volume witnessed a 1% decline primarily with positive soft drink volume growth being more than negatively offset by non-carbonate soft drink volumes.
Some of the most recognized beverages in the company’s portfolio are Dr Pepper, 7UP, Canada Dry, Sunkist, Crush and Snapple. Dr Pepper Snapple competes primarily with PepsiCo (NYSE:PEP) and Coca-Cola Co (NYSE:KO), among others.
We have lowered the price estimate to $38.61. The new price estimate incorporates Q1 earnings.
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Margins Hit By Soaring Costs
Even though the revenues increased 2%, net income dropped 11% mainly because of higher cost of sales. The cost of sales, as a percentage of revenues, now stand at 42.9%, compared to 41.1% in the previous year. This comes in spite of price increases in the range of 3% implemented in 2011. We expect some deterioration in the full year EBITDA margins for 2012. The company expects the cost of raw materials to rise by 7-9% for 2012.
Soft Drinks Performing Well
Carbonated Soft Drinks (or CSD) volumes jumped 2% which is impressive given that the overall market size is decreasing. CSD volumes were helped by the launch of Dr Pepper TEN, the mid calorie variant of Dr Pepper, in the fourth quarter of 2011. Overall, we expect the company to gain market share in the North American CSD market helped by distributional gains. Just to emphasize that point, Dr Pepper Snapple added 43,000 valves and 25,000 cold drink points in 2011.
Dr Pepper has been gaining market share in the last few years as PepsiCo and Coca-Cola Co focus on international expansions. However, this could be a tough year with PepsiCo ready to spend an additional $600 million on marketing and Coca-Cola investing $ 2 billion in the U.S. itself in 2012.
Weak Performance by Non-Carbonated Beverages (NCB)
NCBs continued to perform weakly for Dr Pepper Snapple with volumes witnessing a 7% decline. Only Snapple has performed consistently for the company in the last few years. Snapple’s volume grew 5%. Volumes for Hawaiian Punch and Mott’s declined by 21% and 16% respectively primarily because of greater than expected increase in the cost of sales (mainly apple concentrates) which were subsequently passed on to consumers.
Mixed Results for Latin American Division
The company’s Latin American operations, which includes Mexico and the Caribbean, saw a volume growth of 4%. However, revenues from the region remained flat at $91 million due to relative strengthening of Mexican Peso against the USD. Some of the key brands in this division include Peñafiel, Squirt, Clamato and Aguafiel. The Latin American division contributes only 5% to the stock price as per our estimates.
The company saw a huge reduction in its cash reserves which now stand at $192 million, compared to $701 million as of December 31, 2011, mainly due to expenditure associated with the reduction of income taxes payable (down to $40 million currently from $530 million on December 31, 2011). Thus, we expect a substantial increase in the net working capital for 2012 due to reduction of income taxes payable.