Don’t Rush To Buy This Stock
Gayatri is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the last several months, there has been a lot of noise with respect to the energy drink category, both in terms of various investigations into whether or not these products are safe to consume and in terms of both slower growth and higher promotional spending in the U.S. energy drinks category. There have been letters sent to the FDA by two congressmen, and the New York State Attorney General is investigating the category. As a result, most of the beverage companies have underperformed the broader markets over the last few months. The following chart summarizes the stock movement of beverage companies like The Coca Cola Company (NYSE: KO), PepsiCo (NYSE: PEP) and Monster Beverage (NASDAQ: MNST) over the last 3 months.
Monster’s stock price has been an impressive story in recent years as the stock outperformed the S&P 500 handily in both 2010 (+36% vs. +13%) and 2011 (+76% vs. +0%). However, since reaching an all-time high close price of $78.72 on June 18, 2012, shares of Monster are down ~30%. But does this recent weakness offer a good entry point? Well, it is a tricky question to handle at this point.
As far as the ongoing investigation is concerned, I am optimistic that any changes to come will not meaningfully affect either the energy drink category or Monster’s position in it. Even if the energy drink manufacturers were required by the FDA to stop using a certain ingredient for whatever reason, they should be able to reformulate their products fairly quickly and maintain both the taste and effectiveness of the product in the eyes of consumers. That said, I believe that in the near-term, the uncertainty surrounding the timing and extent of these investigations will represent an overhang on Monster’s shares.
Monster has consistently outperformed the category with steady market gains in the U.S. However, there have been concerns that the rate of growth in the U.S. energy drink category may be slowing. I think a slowdown in category growth is inevitable due to difficult year ago comparisons, but I am more concerned about the competitive threat posed by Coca Cola and PepsiCo. Presently, the energy drink market is dominated by Monster and Red Bull, and both PepsiCo and Coke lack strong energy brands.
But both Pepsi and Coke have the ability to turn it around in the near future. Pepsi (~$110 billion) and Coke ($178 billion) have a market cap more than ten times that of Monster and have ample cash on hand. It is a no-brainer that sooner or later they are going to focus on the fast growing energy drinks category and if they are able to launch a successful energy drink, their marketing budget and international presence could overwhelm Monster.
In addition, Monster lacks diversification and generates over 90% of its revenues from energy drinks, which makes it a risky stock to hold. Monster is trading at a forward PE of 22.5 as compared to Coke at 17.7x and PepsiCo at 16.1x. While I agree that Monster deserves to trade at a distinct premium to its beverage peers given its superior growth prospects, the lack of visibility into Monster’s future earnings and the controversies surrounding the energy drink category make this stock not cheap enough to be considered a “must buy” valuation. Despite the recent weakness, I think the risk-reward profile remains fairly balanced. I would suggest investors wait for a pullback before buying this stock.
GayatriSharma has no positions in the stocks mentioned above. The Motley Fool owns shares of The Coca-Cola Company and PepsiCo. Motley Fool newsletter services recommend Monster Beverage, PepsiCo, and The Coca-Cola Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.