Are These Beverage Valuations Too Hyped?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Energy drinks and Soft drinks containing fructose as a sweetener have been associated with negative health consequences. There is growing scientific evidence in support of fructose leading to higher-calorie diets and obesity. The allegations about energy drinks are not substantiated by such extensive data. True or not, the perception of health problems believed to be associated with energy drinks can reduce demand and inspire regulatory action.

Investors really should require low valuations in this industry. Inexplicably, valuation multiples are currently too high for investors to take a sip.

Valuation Considerations

Non-alcoholic beverage companies are not cheap by any stretch of the imagination:

<table> <tbody> <tr> <td> <p><strong><span>Ticker</span></strong></p> </td> <td> <p><strong><span>Company</span></strong></p> </td> <td> <p><strong><span>P/E</span></strong></p> </td> <td> <p><strong><span>P/S</span></strong></p> </td> <td> <p><strong><span>P/B</span></strong></p> </td> <td> <p><strong><span>P/</span><span>FCF</span></strong></p> </td> </tr> <tr> <td> <p><span>DPS</span></p> </td> <td> <p><span>Dr Pepper Snapple</span></p> </td> <td> <p><span>15.67</span></p> </td> <td> <p><span>1.59</span></p> </td> <td> <p><span>4.12</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>KO</span></p> </td> <td> <p><span>Coca-Cola</span></p> </td> <td> <p><span>19.25</span></p> </td> <td> <p><span>3.48</span></p> </td> <td> <p><span>4.99</span></p> </td> <td> <p><span>53.6</span></p> </td> </tr> <tr> <td> <p><span>KOF</span></p> </td> <td> <p><span>Coca-Cola </span><span>FEMSA</span></p> </td> <td> <p><span>31.94</span></p> </td> <td> <p><span>2.79</span></p> </td> <td> <p><span>4.12</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>MNST</span></p> </td> <td> <p><span>Monster Beverage</span></p> </td> <td> <p><span>26.79</span></p> </td> <td> <p><span>4.18</span></p> </td> <td> <p><span>9.39</span></p> </td> <td> <p><span>29.63</span></p> </td> </tr> <tr> <td> <p><span>PEP</span></p> </td> <td> <p><span>PepsiCo</span></p> </td> <td> <p><span>18.88</span></p> </td> <td> <p><span>1.67</span></p> </td> <td> <p><span>5.12</span></p> </td> <td> <p><span>50.62</span></p> </td> </tr> </tbody> </table>

For comparison, the Standard & Poor’s 500 average price-to-earnings ratio is 14.20, it’s average price-to-book-ratio is 2.03, and its average price-to-sales ratio is 1.30. Comparatively, the multiples of  Coca-Cola (NYSE: KO), Coca-Cola FEMSA (NYSE: KOF), Monster Beverage (NASDAQ: MNST)PepsiCo (NYSE: PEP) are off the charts. Dr. Pepper Snapple (NYSE: DPS) is priced more reasonably, but it still trades at higher multiples than the broader market. This really make no sense given the societal implications of obesity and the threat of government response.

Health Issues for Energy Drinks

You might think that energy drinks are the opposite of traditional soft drinks in that they boost metabolism and might be conceived as part of a weight-loss strategy. Unfortunately, such ideas are overwhelmed by other health concerns that have surfaced.

The U.S. Food and Drug Administration released a list of health problems that were somehow associated or could be connected to energy drinks, including abdominal pains and increased heart rates. With incidents dating back to 2004, the report included incidents associated with drinks like Rockstar, 5-Hour Energy, and Monster.

5-Hour Energy was somehow related to 92 incidents that include 33 hospitalizations and 13 deaths. Red Bull was mentioned in 21 event reports, including 4 incidents of hospitalizations. Monster was somehow present in 40 reports, including 20 hospital check-ins and five fatalities. Thankfully Rockstar was not present in any fatalities, but it was identified in 13 incidents. None of this is definitive, and energy drinks could just be coincidentally present in these cases. However, investors have to accept there is a risk that some connection could be established.

Clearly, Monster shares should not trade at a 26.79 earnings multiple.

Fructose Linked to Obesity

Fructose is a huge component of Dr Pepper Snapple, Coca-Cola, Coca-Cola FEMSA, and PepsiCo products. These companies will face headwinds as governments and health advocates find ways to curb their consumption.

According to a study by Yale University, fructose might contribute to weight gain and obesity because it doesn’t cause brain activity associated with feeling full. A study in the Journal of the American Medical Association compared the response from the human brain to fructose and glucose through the use of Functional Magnetic Resonance Imaging (fMRI) as a way to quantify the organ's activity once the sweeteners had been consumed.

Glucose is a sugar that comes from fruits, vegetables, starches, and other natural foods. Even while fructose is a sweetener obtained from beets, corn and sugar cane, it is heavily used by the food and drinks industry as it has an increased sweetness in comparison to glucose. This makes it an ideal addition to processed and refined foods and drinks, so that their sweetness isn't compromised by transportation, a longer shelf life or any industrial processes such as freezing.

There had previously been the suspicion that a rise in consumption of fructose-flavored food might be one of the many contributors to the U.S. obesity epidemic. As the number of American adults who are obese has more than doubled to almost 80 million in the last 30 years, a better understanding on the interactions between nutrition and our brain and body is well needed to stop such health issue.

One of the findings of the study was that the consumption of glucose had a "significantly greater" reduction in blood flow to the hypothalamus, insula, and striatum, areas of the brain that are in charge of the regulation of appetite. This reduction in blood flow stops people from wanting to eat more. On the other hand, the consumption of fructose did not exhibit such a brain response. About this, Robert Sherwin, professor of medicine at Yale, said, "The data surely suggest that it’s probably not in your best interest to have high fructose-containing drinks because they’re not going to cause you to be full, and you’ll tend to consume more calories."

While future studies should compare the effect of fructose and glucose in real world conditions, possibly through the ingestion of typical foods, it shouldn't be hard to figure out that a lower ingestion of processed and refined foods and drinks should be one of the steps in the reversal of our current obesity trend.

Investors Should Diet

Investors should avoid these non-alcoholic beverage companies because they are now widely thought to be connected to health risks. Investors should be weary of them in the same way that they should be weary of tobacco stocks, and they should only buy them at valuations that reflect risks to future earnings. At present, these stocks are trading at growth price multiples and should be avoided.

BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, Monster Beverage, and PepsiCo. The Motley Fool owns shares of Monster Beverage and PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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