You Can Almost Taste the Value Packed into Dr Pepper Stock

By Tom Gibbs - June 13, 2012 | Tickers: KO, DPS, MNST, PEP, DIS | 0 Comments

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The soft drink market has recently experienced a game changing shakeup as external macro forces are threatening the profitability of each of the three key players in the field – Coca-Cola (NYSE: KO), Pepsico (NYSE: PEP), and Dr Pepper Snapple (NYSE: DPS).  Not only has intra-industry competition (i.e. “The Cola Wars”) become hotter than ever, but battles are also increasingly being fought in-house as the enterprises juggle rising commodity costs, changing consumer tastes, and more intense government regulation. 

Dr Pepper Snapple, due its relatively small size and youth in the publicly traded space (it spun off from Cadbury in 2008), tends to receive significantly less attention than the industry heavyweights or other newcomers, including the swiftly growing Monster Beverage (NASDAQ: MNST).  There are several key reasons, however, that the corporation is bound to receive a disproportionate amount of attention.

Healthier Financial Position

Dr Pepper Snapple has made significant operational progress in its post-spin off period, honing its near 60 portfolio names into a core group of around 15 and investing heavily in key names including Dr Pepper, 7-Up, Canada Dry, A&W, Snapple, and Motts.  Likewise, huge progress has been made on the distribution-end of Dr Pepper’s business.  The corporation now has five mega-plants strategically positioned around the United States and controls a much more efficient hub-and-spoke network, which will lead to significant growth when compared to the old set up involving Cadbury producing most of the product in the Northeast and shipping it around the nation. 

As a result of the meaningful operational changes, Dr Pepper has been able to significantly streamline distribution while simultaneously cutting its workforce by 5% over the past 5 years.  The corporation’s operational efficiency gains have acted as a hedge of sorts against the rising commodity costs plaguing the industry.  Although gross margins fell 230 basis points between 2010 and 2011, for instance, operating margins only fell 84 basis points as operating costs as a percentage of sales continue to fell.  The same cannot be said for more mature players including Coca-Cola – gross and operating margins fell 300 and 224 basis points, respectively, between the same time period. 

The improved performance has led to a boost in Dr Pepper’s return on invested capital, which rang in at 20.9% over the past 12-month period.  Not only does this represent a nice improvement from the 18.5% return in 2009, but it also puts Dr Pepper more in league with the large players – Coca-Cola and Pepsico generated 21.6% and 19.4% returns on invested capital, respectively, over the past four quarters (see footnote for calculation).

Improved Awareness

Second tier cola and other beverage producers have historically received relatively little preferential treatment in terms of grocery shelf space, quick-serve restaurant (QSR) distribution, and partnerships with nationally renowned venues and events.  The continued investment into and stronger performance of each of Dr Pepper’s slimmed-down portfolio brands has led to several exciting distribution announcements that should drive consumer awareness gains over the mid-term.

• The NFL’s Chicago Bears recently ended its decades-long partnership with Coca-Cola for an exclusive, seven-year deal with Dr Pepper Snapple.  The beverage producer also carries rights to use the Bears logo and trademarks on its products, which will be useful in local advertising initiatives and can continue to push the brands beyond their home station in the Texas/Oklahoma region.
• Marvel’s (NYSE: DIS) The Avengers is all the hype this summer season, and now consumers can be on the lookout for Dr Pepper collectible cans featuring some of the film’s most popular heroes.  Commercial spots and a custom online game will supplement the ad campaign.
• Partnership with the Food Network’s Guy Fieri, who will use Dr Pepper beverages in his recipes – perfect for the summer grilling season.
• America’s Got Talent.  “The Best Stuff on Earth” has recently signed for a seven-season deal with NBC’s hit summer talent competition. 
• Dr Pepper should begin enjoying increased awareness within the Hispanic community through its partnership with Univision’s Premios Juventud VIP Tour, the most popular awards show for Spanish-speaking celebrities in film, music, sports, fashion, and pop culture.  The program was, for the fourth consecutive year in 2011, the most watched program for the 18-34 age group (regardless of language) in its time slot.

Possible Multiple Expansion

Coming with Dr Pepper’s perpetual third place positioning in the soft drink industry is also the market’s lack of desire to ante up for the corporation’s earnings:

• Current P/E
• Dr Pepper: 15.86x
• Pepsico: 16.90x
• Coca-Cola: 19.91x
• Forward P/E (2013 earnings estimates)
• Dr Pepper: 13.62x
• Pepsico: 15.37x
• Coca-Cola: 16.79x
• 5 Year Average P/E
• Dr Pepper: 15.54x
• Pepsico: 17.59x
• Coca-Cola: 18.59x

With the stronger outlook on Dr Pepper stock, however, it is difficult to believe that the corporation will continue to be awarded relatively depressed earnings multiples.  Based on 2013 consensus earnings estimates, for instance, Dr Pepper’s two year EPS growth (from this past fiscal year) of 16.1% would be in league with Coca-Cola’s and Pepsico’s growth estimates of 20.9% and 10.2%, respectively.  Expected five year growth rates from 2009 lows also show that Dr Pepper is not a significant industry laggard: the 46.5% projected growth compares with Coca-Cola’s 52.2% and Pepsico’s 17.8% rates.  The continued earnings improvement, combined with the continued stagnation of Pepsico’s troubled operations, should give Dr Pepper stock much needed excitement and broader awareness.

Investors should look further into the growth story of Dr Pepper stock.  The aforementioned factors, as well as the expected correction in key commodities including aluminum and sugar, should lead to a level of earnings never before experienced by the corporation.  It is hard to imagine Dr Pepper Snapple continuing to receive further market pessimism especially when it is growing at long-term rates that are nearly on par with the much-loved industry favorites. 

Footnote:

--Pre-Tax return on invested capital defined as (Operating Income)/(Invested Capital)

--Invested Capital defined as ((Operating Assets – Financial Assets) – (Operating Liabilities – Financial Liabilities)).  Excess cash (above and beyond 5% of annual sales) stripped out of financial assets. 

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