The Market Is Still in Denial...

By Brian Shaw - February 20, 2013 | Tickers: CPB, KO, DPS, SODA | 0 Comments

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Six months ago, I made the bold statement that "the market is in denial" with respect to SodaStream (NASDAQ: SODA) and its long-term investment thesis. Despite a 26% increase in the SodaStream's stock price since that analysis, the market's reaction to SodaStream's record fourth-quarter earnings demonstrates that investors still don't appreciate the great growth story that is unfolding.

Revenue grew 51% for the year while net income grew 60% over 2011. However, the market rewarded these results with a 6% decline in share price that can be explained by little more than "the market was expecting more."

What exactly was the market expecting? As Rick Munarriz summarized in an article shortly after the earnings release, SodaStream exceeded analyst expectations by a comfortable margin (yet again). So what is the problem?

Were higher expectations already priced into the stock? 

Here's a comparison of the valuation of SodaStream from August 2012 through February 2013:

Despite the increase in share price since August, the comparison above shows a pretty compelling argument that SodaStream is trading at an equal or lower valuation today than it was last year. Has anything changed? Certainly, but the changes have been almost exclusively positive, as described below:

• Revenue growth is fantastic - Those hanging onto the idea that home soda making is a fad may want to take note of the top line growth. In addition to selling over a million soda makers in a quarter for the first time, SodaStream delivered impressive revenue growth no matter how you look at it. In the Americas, revenue increased 96% over the fourth quarter of 2011 and every geographic market increased revenue by at least 28%. Revenue from new soda makers grew 62%, but the revenue for consumables such as carbonators and soda mixes that really show the level of use of SodaStream systems increased 54%.
   
• Partnerships are starting to have a meaningful impact - In addition to the 2012 partnership with Kraft that brought Kool-Aid, Crystal Light and Country Time branded soda mixes to SodaStream, a partnership with Campbell Soup (NYSE: CPB) is bringing V8 flavors to SodaStream in the near future. Based on Kraft's desire to expand the scope of its partnership with SodaStream several times, all evidence points to the arrangements being a win-win situation for both SodaStream and its partners. The potential for growth has significant appeal to a low-growth company like Campbell, which is looking for growth drivers to exceed analysts' expectation of just 5% growth over the next five years. As a result of this initial success in attracting brand names, it would not be unreasonable to expect other beverage providers such as Dr Pepper Snapple (NYSE: DPS) and Monster Beverage to sign up.
   
• Alliances with appliance makers - In a completely different type of partnership, Samsung recently announced plans to integrate SodaStream systems into high-end refrigerators. This is yet another piece of evidence supporting the thesis that SodaStream is starting to become a permanent player in beverage consumption markets, and it is especially reassuring to see appliance vendors signing on as partners rather than creating competitive offerings.
   
• Increased consumer awareness - In the United States and other high-growth markets for SodaStream across the globe, brand awareness is starting to gain traction. This has been achieved through expanded distribution by distributors as varied as Costco Wholesale and Williams-Sonoma. Additionally, SodaStream's marketing initiatives have been expanded greatly, including a clever Super Bowl ad (and even the banned commercial, which has almost five million YouTube views in a matter of weeks). 
   
• Competition is non-existent - It is well known that Coca-Cola (NYSE: KO) and PepsiCo have well-established market leadership positions in the soft drink industry worldwide. However, thus far Coca-Cola and Pepsi have chosen to ignore the home soda-making movement for the time being. Additionally, small kitchen appliance manufacturers haven't made a serious entrance into the market, leaving SodaStream with additional time to expand its market share and leverage its first-mover advantage. 

So what went wrong?

With the investment thesis appearing to solidify every day, the market's negative reaction to SodaStream's earnings appears even more confusing. Investor's Business Daily attributes the decline after the earnings release to gross margin declining slightly year-over-year. While that is a true statement and something worth monitoring, that seems like a pretty weak flaw to nitpick given the huge growth on both the top and bottom lines.

The ever-present risk that Coca-Cola could develop a next-generation Coca-Cola Freestyle machine for the home is certainly a risk, but there's no indication that such a product is in development at this time. Plus, at a market capitalization of just $1 billion, it could make more sense for Coca-Cola to just acquire SodaStream rather than develop its own product and then have to establish sales channels with major retailers with which it currently has no relationship.

Guidance isn't the issue either. Management forecasts revenue and adjusted earnings growth of 25% in 2013. While 25% is a solid growth target by itself, management's history of over-delivering in recent periods indicates the potential for additional upside beyond 25%. This is not significantly out of line with analysts' expectation of annual growth of 30% over the next five years.

Looking at 2013 and beyond

In 2013, investors should expect more of the same from SodaStream's operations. Steady growth across geographic markets and an increasing base of users that re-order consumables such as carbonators and soda mixes should really demonstrate the power of this razor and blade model.

Based on the partnerships noted above, it would not be surprising for the existing partnerships to expand and/or new partnerships to be announced. Partnerships with Dr Pepper Snapple or Monster Beverage would be huge wins in SodaStream's mission to further entrench itself in the marketplace. An acquisition bid by Dr Pepper Snapple is always a possibility as well (albeit complete speculation at this point) given the company's desire to gain market share from incumbents Coca-Cola and PepsiCo; with an enterprise value more than 11 times SodaStream's, the scale of a deal would be realistic to execute.

There are a few risks to keep in mind. First, competition from either Coca-Cola or kitchen appliance makers is certainly something to be mindful of as the home soda market continues to expand. At the moment, there are no credible threats on the horizon, but that can certainly change. Second, the rate of consumable sales is an important consideration; the sure sign that SodaStream is losing popularity would be a decline in the sale of consumables. With that said, it is important to note that there is an expectation that there is a degree of seasonality to soda sales that is skewed towards warmer months.

A look at SODA's valuation

After concluding that the market has continued to under-appreciate SodaStream, the logical next question is what is the stock worth? In this author's opinion, a fair price for the stock of a high-growth company with no debt is a PEG ratio in the range between 1.0 and 1.2. With a PEG of 0.75 today based on analysts' estimated growth rate of 30%, SodaStream appears to be undervalued. Applying a PEG of 1.0 and 1.2 to the existing set of available data would result in a share price between $65 and $79. That's a 30-60% premium over today's prices, which highlights the opportunity that remains for investors in the near to mid term.

Over the longer term (five years or more), there are very reasonable sets of assumptions that can justify predictions of multi-bagger returns. That's plenty of upside for those investors that are willing to ride the volatility of a small-cap stock with a high percentage of shorts like SodaStream.

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