Here’s Why Keurig Dr Pepper Stock’s 80% Rally Is Not Surprising

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KDP: Keurig Dr Pepper logo
KDP
Keurig Dr Pepper

Keurig Dr Pepper stock (NYSE: KDP) has seen an impressive rise of 80% from its March 2020 lows. We believe that this sharp rise makes complete sense as the company’s business was hardly affected even during the pandemic, when other food and beverage companies saw major disruption. KDP stock has increased from less than $20 to almost $36 off the recent bottom, in line with the S&P which also increased close to 80% from its recent lows. The stock price rise was driven by expectations of rising demand and easing of supply constraints following the gradual lifting of lockdowns and a successful vaccine rollout. Even though the stock is almost 40% above the level seen at the end 2018, it is not overvalued. In fact, it is fairly valued at the moment. The company’s low reliance on concentrates and greater exposure to coffee and brewing systems will keep the stock elevated around the current level. Our dashboard Buy Or Sell Keurig Dr Pepper Stock has the underlying numbers.

Some of the stock price rise between 2018 and 2020 is justified by the 56% 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 amplified by a 45% rise in net income margin, which increased from 7.9% in 2018 to 11.4% in 2020. On a per share basis, earnings increased almost 75% from $0.54 to $0.94 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 34x 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 but not as much as the EPS between December 2018 and December 2020 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 38x, higher than the level seen over the last two years.

Outlook

The global spread of coronavirus in early 2020 affected industrial and economic activity, which affected consumption and consumer spending. However, KDP has not been impacted much by the pandemic. This was evident from the recent quarters’ results for the company. KDP revenues increased 4.5% in 2020 compared to 2019, even though most of the beverage giants saw a dip in top line during the year.

What has helped KDP’s stock rally 80% in a year? 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) continues to see growth as working at home by millions of people is benefiting 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 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 and vaccine coverage widens, the company’s business is expected to grow even faster, as demand is expected to pick up. The recent spike in Covid cases has not affected the stock as the company was able to successfully thrive during the crisis in 2020, which is giving investors confidence that if the cases rise further, KDP will be able to replicate its last year’s resilience. The company has outperformed its peers in the food & beverage industry and investors’ focus has shifted to 2021 and 2022 numbers. Thus, continued revenue and earnings growth with an elevated P/E multiple is likely to keep the stock around its current level. According to Trefis, KDP valuation gives a fair price estimate of $35 per share for KDP’s stock.

While KDP stock may have moved, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how the stock valuation for Coca-Cola vs Merck shows a disconnect with their relative operational growth. You can find many such discontinuous pairs here.

 

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