How Would Robust Volume/Mix Along With Synergies Affect Keurig Dr Pepper’s Top Line And Profitability In Its 2018 Results?

Keurig Dr Pepper (NYSE: KDP), a leading coffee and beverage company in North America, is set to announce its Q4 2018 results on February 28, 2019, followed by a conference call with analysts. This would be the second quarterly results of the company after its merger with Dr Pepper Snapple. The market expects the company to post adjusted earnings of $0.30 per share in Q4 2018, 25% higher than $0.24 in Q4 2017. Total revenue is expected to be approximately $2.84 billion in Q4 2018, which would mark a whopping increase of 72.9% on a year-on-year basis. Higher revenues and superior adjusted earnings would likely be a reflection of robust volume/mix which is attributed to improved shipment volumes for Dr Pepper, Canada Dry, Core Bai and BODYARMOR brands, continued growth in the ginger ale category, expansion of and market share gains in the coffee portfolio, along with a lower tax expense following the implementation of the Tax Cuts and Jobs Act, partially offset by higher interest expense on the back of increased debt as the company assumed DPS’s debt after the merger.

We have summarized our key expectations from the company’s 2018 results in our interactive dashboard – Keurig Dr Pepper Likely To Achieve Better Top Line Growth Due To Robust Volume/Mix In 2018. In addition, here is more Consumer Staples data.

Key Factors Affecting Earnings

Growth in coffee: The global ready-to-drink tea and coffee market size is expected to reach $135 billion by 2024, growing at a CAGR of 8.4%. Thus, the coffee segment provides immense growth opportunities for KDP, which is seeing volume growth of pods and brewers. Further, it is expanding the coffee portfolio on the back of unit growth for the single-serve pod category as well as improved market share for pods produced by Keurig Dr Pepper. In Q3 2018, 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.

Bai Brand: As the young generation is shifting away from carbonated soft drinks due to changing preferences, increased awareness, and health concerns, demand for healthier alternatives is increasing. This trend is likely to help KDP as Bai is the front-runner for the company in terms of healthy-beverage options. In Q3 2018, Bai’s volumes increased by about 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. Additionally, while there are still distribution opportunities for its enhanced water product, opportunities also lie in other platforms, such as Bubbles, Super Tea, and Black. The Latin America beverages segment is expected to witness revenue growth of 8% in 2018.

Ginger Ale: With the millennials preferring more authentic, quality beverages having natural flavors, the company has witnessed steady growth in the ginger ale category. Ginger, a sought-after flavor, was also ranked in the top 10 in Google’s 2017 Beverage Report. Additionally, ginger beverages have been gaining traction in markets such as US, UK, Spain, and Mexico. Sales of ginger ale is likely to remain strong in Q4 2018 and beyond, contributing to higher sales from the beverage concentrates segment. We expect revenues from this segment to grow by 3.5% in 2018 followed by a 3% rise in 2019.

Profitability: KDP expects merger-related synergies totaling about $600 million over the next three years, with $200 million in savings expected per year. This is expected to help in providing a fillip to margins. Additionally, lowering of the corporate tax rate from 35% to 21% following the implementation of the Tax Cuts and Jobs Act in 2018 is expected to lead to lower tax outgo and thus boost margins. However, we expect the upside in the net income margin to be limited due to higher interest expense. With the merger with DPS, Keurig Dr Pepper has assumed all of DPS’s senior unsecured notes amounting to approximately $12 billion, which has led to almost a three-fold rise (y-o-y) in the consolidated debt of the company at the end of Q3 2018. Higher interest expense along with currency headwinds is likely to adversely affect margins in 2018. We expect net income margin to increase to 18% in 2018 from 16.1% in 2017. The upward trend is expected to continue in 2019 as well.

We have a price estimate of $27 for the company, almost in line with its current market price. Management recently announced a quarterly dividend program and declared its first dividend of $0.15 per share. Thus, we believe that improving margins, coupled with management’s renewed focus on enhancing shareholder returns, would support KDP’s stock price in the near future.

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