Soda Companies Fear this Monster

By Eric Novinson - March 29, 2012 | Tickers: KO, MNST, PEP | 0 Comments

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Monster (NASDAQ: MNST) stock looks overvalued at first glance, as the Fool's Tamara Rutter explains. A price to earnings ratio of 40 seems high when competitors often trade closer to 15. Additionally, Monster competes in a market with few barriers to entry, several large companies already sell similar products, and sales in the sector fell for the last seven years. She recommends Monster anyway, and so do I.

Monster offers a specialty product, so a direct comparison with other beverage companies does not show the energy drink maker's full potential. Soft drink makers often market their products as thirst quenchers and refreshing beverages, not performance enhancers. Although soft drinks have some capacity to boost a shopper's energy levels, energy drinks provide much more of a kick.

Monster sells soft drinks that provide vitamins and an additional energy boost. I once read a quote about technology companies that stated when you can describe a startup's product as an established company's product, plus several additional features, you are describing a replacement for the established company's product. You could call it Soda 2.0. Replacing established soda makers is an ambitious goal, and Monster's stock price suggests that its investors believe the company can accomplish it.

Monster's market cap of $10.8 billion seems high for an energy drink company with $1.7 billion in revenue. Pepsi (NYSE: PEP), which sells energy drinks, traditional soda, and chips, reports much higher revenue at $66.5 billion, and has a market cap of $103.6 billion. Coca-Cola (NYSE: KO) has $46.5 billion in sales, and a $164.4 billion market cap. Of course, Monster's rapid growth provides much of the explanation for its market cap. Monster's 26.8 percent operating margin also stands out here, as it surpasses Coke's 23.4 percent margin and Pepsi's 15.6 percent margin. As an energy drink manufacturer, Monster has more pricing power than a traditional soda maker. I just went to the local convenience store, and cans of Monster cost $2.50 each. A can of soda costs around $1. In bulk, energy drinks can still cost much more than standard soft drinks. A box of four energy drinks costs $7.50 at my local grocery store, where boxes that contain 12 standard soft drinks are going for $2 each.

Pepsi and Coca-Cola know that shoppers will pay high prices for energy drinks, and both companies developed their own energy drink brands. This competition doesn't seem like it has affected Monster's profits much. Monster sustained its performance while Coke had its Full Throttle drink on shelves and Pepsi sold its AMP line. Monster doesn't seem very vulnerable to competition, even without an effective moat or barrier to entry, as Pepsi and Coca-Cola are larger than many other potential market entrants.

In a recent post, I predicted that beverage companies that expanded their product lines beyond soft drinks, including Coca-Cola and Pepsi, would perform better because of the shrinking market for traditional soft drinks. Monster has already responded to this trend. Shoppers who don't want to purchase a soda based energy drink can purchase Monster's tea based energy drinks instead, and the company offers several flavors. Monster even sells coffee flavored energy drinks. Coca-Cola owns Honest Tea and Pepsi owns the SoBE and Tazo tea brands, so Monster already competes with two larger rivals in the tea market.

Monster's sales improved from $1.02 billion in 2007 to $1.95 billion in 2011, rising sharply from $1.49 billion in 2010. Monster's net income, at $286 million in 2011, is also nearly twice the $149 million it earned in 2007. The company also has more than twice as much cash on hand as it held in 2007, so it can afford to expand its operations in the future. Monster looks like a solid investment to me.

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