Despite more than a 60% rise since its March 2020 lows, at the current price of $32 per share, we believe Keurig Dr Pepper stock (NYSE: KDP) is close to its fair value. KDP stock has increased from less than $20 to almost $32 off the recent bottom, slightly less than the S&P which increased by 70% from its recent lows. Even though the stock is around 24% above the level at which it was at the end of 2018 and 8% above its pre-Covid (February 2020) high of $29.50, we believe that KDP stock’s recent rally is justified. The stock price rise was driven by expectations of rising demand and easing of supply constraints following the gradual lifting of lockdowns. Additionally, the company’s low reliance on concentrates and greater exposure to coffee and brewing systems will keep the stock elevated and could, in fact, even see a marginal upside. Our dashboard Buy Or Sell Keurig Dr Pepper Stock has the underlying numbers.
Some of the stock price rise between 2018 and 2019 is justified by the almost 50% rise in KDP’s revenues. Revenue growth was mainly due to the acquisition of Dr Pepper Snapple by Keurig Green Mountain which led to the formation of Keurig Dr Pepper. This effect was further accentuated by a 43% rise in net income margin, which increased from 7.9% in 2018 to 11.3% in 2019. On a per share basis, earnings increased 65% from $0.54 to $0.89 as shares outstanding also increased due to shares of both companies being combined.
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KDP’s P/E multiple dropped sharply from 48x to 33x during this period. This was not because of a change in company’s fundamentals but due to the sharp rise in the EPS following the acquisition. The stock price increased only at a modest rate between December 2018 and December 2019 as the effect of the acquisition was already accounted for in the price, leading to a drop in P/E. Despite the coronavirus pandemic hitting the world in 2020, KDP has been almost immune to the crisis as is reflected in its current P/E multiple of 36x, higher than the 2019 level.
The global spread of coronavirus in early 2020 affected industrial and economic activity, which affected consumption and consumer spending. However, KDP has not been affected much by the pandemic. This was evident from the recent quarters’ results for the company. KDP revenues registered a y-o-y growth of 1.8% and 5.2% in Q2 2020 and Q3 2020, respectively.
If KDP’s business was not much affected by the crisis, then what has helped KDP’s stock rally 60% in recent months? It is the revenue mix of the company. Hardly 13% of KDP’s total revenues comes from concentrates (which are sold to affiliates that manufacture syrups used in fountain drinks). Quarantine and home confinement led to a slide in fountain sales and a corresponding decline in demand for concentrates. But KDP, which derives 44% of its revenue from bottled beverages (ending up in grocery and convenience stores) and 38% of sales from Keurig brewing systems and K-Cups, benefited directly from the sudden surge in at-home consumption, with manageable exposure to decreased concentrate sales. With people moving away from carbonated drinks and replacing the same with beverages like coffee, KDP has an edge over rivals Coca-Cola and PepsiCo, as its coffee segment (38% revenue share) will see growth as working at home by millions of people will benefit the company’s direct and licensed K-Cup coffee sales. Also, KDP’s revenue is concentrated in the US and Canada, with its only international division – Latin America – making up only 5% of revenue. This has helped KDP to suffer less from global supply-chain disruptions due to the Covid-19 versus companies like Coca-Cola which have a large, global distribution system.
Any further recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. As the global lockdowns are gradually lifted, the company’s business is expected to grow even faster, as demand is expected to pick up. The company has outperformed its peers in the food & beverage industry and investors’ focus has shifted to 2021 numbers. Thus, continued revenue and earnings growth with an elevated P/E multiple is likely to keep the stock around its current level. As per Trefis analysis, KDP valuation works out to $33 per share.
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