Keurig Dr Pepper’s Stock Declines On A Third Quarter Miss

by Trefis Team
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Keurig Dr Pepper (NYSE: KDP) reported its first earnings as a combined company, posting a 2.9% growth in sales, 240 basis points improvement in the operating margin, and an EPS of $0.30, versus $0.21 last year. However, its performance failed to match consensus expectations, resulting in a fall in the stock price. The company stated that its retail market performance remained strong in the quarter, with market share gains noted in CSD, coffee portfolio, and flavored water, resulting in revenue growth. Meanwhile, the earnings improvement was primarily due to the reduction in the effective tax rate. For the full year, the company is anticipating the adjusted diluted EPS to be in the range of $1.02 to $1.07. Furthermore, KDP expects the merger synergies to total $600 million over the 2019-2021 period, with $200 million in savings expected each year.

We are in the process of updating our model based on the pro-forma financials of the merged entity.

Factors That May Impact Future Performance

1. Popularity of Ginger Ale: Canada Dry had a double-digit gain in volumes in the third quarter due to steady growth in the ginger ale category and product innovation. The increasing popularity of ginger ale has been driven by millennials, as they look for more authentic, quality beverages having natural flavors. Ginger beverages have been gaining traction in many markets around the world, with demand growing strongly at a 32% year over year growth rate across the U.S., U.K., Spain, and Mexico.  Ginger, a sought-after flavor, was also ranked in the top 10 in Google’s 2017 Beverage Report. This segment is expected to continue its strong growth in the remainder of the financial year.

2. Strong Coffee Growth Expected: The addressable market size of the hot beverage market is roughly $0.7 trillion. Moreover, this segment is growing at a fast pace – 6% annually. This should benefit KDP, as Keurig Green Mountain has a strong coffee portfolio. In the quarter, this segment’s net sales growth was fueled by volume growth of approximately 3% for pods, and 8% for brewers, although the pricing remained weak. The company is aiming to drive its household penetration through the launch of new coffeehouse brewers – the K-Café and the K-Latte – and updated version of its K-Mini brewer platform.

3. Potential of Bai Brands: Bai Brands has tremendous potential to grow and drive KDP’s revenues going forward. As millennials move away from carbonated soft drinks, demand for healthier options is increasing, and Bai is likely to be the front-runner for KDP in terms of healthy beverage options. Moreover, from an ACV (all-commodities volume) standpoint, while there are still distribution opportunities for its enhanced water product, greater opportunities lie in other platforms, such as Bubbles, Super Tea, and Black. ACV is considered an insightful measure for soft drink companies, and can be generally thought of as “% of stores selling,” but with stores weighted based on their size, and hence, reflects the item’s exposure to consumer spending. In the quarter, Bai volumes increased 22% driven by distribution gains, product innovation, and promotional activity, as well as higher sales to third party bottlers in the Latin America Beverages segment.

4. Reduction in Effective Tax Rate: The lowering of the corporate tax rate from 35% to 21% in the U.S., effective January 1, 2018, should positively impact the company. Consequently, the effective tax rate for the third quarter of this year was 27.1%, as compared to 32.2% in Q3 2017. This trend is expected to benefit the results of the full financial year.

5. Growth Potential: JAB Holdings, Keurig’s owner, has acquired a number of coffee brands, such as Jacobs, Peets, Caribou, and Keurig. It has also scooped up Krispy Kreme Doughnuts, Panera Bread, Au Bon Pain, among other food and beverage companies. However, being able to deliver these products to places where the consumers shop requires a massive distribution network, and this is where Dr Pepper Snapple will come in. Furthermore, this deal, the biggest in the soft drinks space, would also result in a hot and cold drinks combination, with immense scale for both. DPS, meanwhile, will benefit from Keurig’s e-commerce capabilities. JAB also has experience in the past of acquiring small brands, and ensuring their fast growth rates continue, an aspect DPS has clearly been struggling with for Bai.

6. Deal With Evian: KDP signed an agreement with Danone Waters of America (DWA) to sell, distribute, and merchandise Evian water. DWA will benefit from KDP’s massive distribution network in the U.S., covering roughly 150,000 large and small format stores across the country. Evian is a leading premium water, in a category growing 15% annually, which should benefit KDP.

 

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