Monster-ly Overpriced Expectations

By Daniel Sparks - September 7, 2012 | Tickers: KO, DPS, MNST, PEP | 0 Comments

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Monster Beverage Corp (NASDAQ: MNST) has seen plenty of success and the end to double digit growth will probably not come for years. But there is one problem . . . these expectations are already priced into the stock.

Monster has seen its share of golden years, and they are not likely to stop soon. Monster has solid gross profit margins of 52%, and earns a return on invested capital of over 31%; more than twice that of Coca-Cola's (NYSE: KO) 13%. Monster even looks like a potential buyout target. Coca-Cola has yet to have experienced much success in the fast-growing energy drink business and Monster Energy Drink makes up 92% of Monster's revenue. There is no doubt that Coca-Cola's international presence would add plenty of value to Monster's international expansion which currently pales in comparison to privately held competitor, Red Bull. Speaking of Red Bull, Red Bull generates more than triple the revenue of Monster, highlighting Monster's opportunity for international growth. Finally, Monster's balance sheet is strong and healthy with plenty of cash and no long-term debt or pension liabilities.

Overpriced Expectations

There is a very high probability that Monster's revenue will continue to soar and it will continue to successfully expand into international markets. This expansion will probably begin to add plenty of incremental values to Monster as its international ventures begin to churn profits. But as Howard Marks so eloquently stated in his book, The Most Important Thing, "There is a big difference between probability and outcome. Probable things fail to happen and improbable things happen all the time."

In other words, the problem with all of these assumptions is that they are nothing but probable expectations. What if things don't pan out as well as expected? At today's valuation, great expectations are already priced into the stock.

Risks to Growth Expectations

1. Competition - PepsiCo (NYSE: PEP) and Coca-Cola may not have strong energy drink brands, but that doesn't mean they won't find success with energy drinks in the near future. Why wouldn't they pursue it? They are both loaded with cash and there is no doubt they have not been at least slightly interested in the success that Monster and privately held Red Bull have seen. If they do launch a successful energy drink, their marketing budget could overpower Monster. In fact, PepsiCo has recently expressed interest in increasing its marketing:

"We will continue to step up our brand support through increased advertising and marketing, accelerate our innovation to drive growth, and drive our aggressive productivity agenda" (SEC filing)

2. Conflicts of interest - Monster's largest distributer also happens to be a competitor. Coca-Cola's competing Full-Throttle has not seen the success of the Monster Energy Drink but Coca-Cola could easily decide to charge more for its distribution services.

3. Private-label energy drinks - Some countries are launching private-label energy drinks that undercut Monster's prices. New entrants into the energy drink market could erode pricing power.

4. Regulation - The health and marketing of energy drinks is in question. Litigation could result in regulation, fees, or even bans of energy drinks' most important ingredient: Taurine.

5. Lack of diversification - If Monster's energy drink fails to meet expectations, there is plenty of downside. With over 92% of its revenue coming from its energy drink, diversification is not Monster's strong point. Consider Dr. Pepper Snapple Group (NYSE: DPS), the leader in carbonated soft drinks with over 50 brands in their portfolio--and this isn't even including its Snapple and Mott's brands. The diversification of PepsiCo, Coca-Cola, and Dr. Pepper Snapple give them more downside protection than Monster's highly concentrated energy drink business.

Bottom Line

So . . . Yes, there is plenty of upside potential for Monster. But there is also some serious downside. At today's price of near $59 there is simply too much risk. It's a great business, but not a great stock . . . at least not at these levels.

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