Don't Underestimate This Beverage Company

Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Dr Pepper Snapple (NYSE: DPS) recently reported its fourth quarter results.  The nation's third-largest soft drink maker saw a 2% rise in profits and a 1% increase in revenues amid slower sales volume. Excluding an accounting measure, earnings were $0.82 per share, compared to the consensus estimate of $0.85 per share, and as a result the shares have seen a 6% correction. Although the numbers posted certainly don’t look high-quality, one must take into account the prevailing weakness in the overall carbonated soft drink market in North America over the past few months. Changing consumer preferences, increasing health consciousness, and growing regulatory pressures are affecting beverage sales of Dr Pepper as well as other beverage companies like PepsiCo (NYSE: PEP) and Coca-Cola (NYSE: KO). PepsiCo has actually experienced a drop in revenue (1%) as well as operating profit (2%) in the fourth quarter.

Dr Pepper began rapid continuous improvement over a year ago, and the company has identified over 200 Kaizen improvements and over $116 million of annualized cash productivity. The company has closed various warehouses, significantly reduced transportation costs, and implemented over 500 safety improvements amidst continuous supply chain related improvements. Going forward, I expect continuous margin expansion and more than $100 million of productivity savings through 2013.

Dr Pepper does not have a vast international presence like Coca-Cola and PepsiCo. However, in my opinion this is a blessing in disguise because the company does not have to deal with the ongoing European crisis. The company is exclusively focused on North America which is not only a huge short-term benefit but also provides a long runway for future international expansion as the company’s brands reach a wider consumer base under an easier macro environment. Let’s take a look at some of the key metrics of Dr Pepper, as well as Coca-Cola and PepsiCo.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Coca-Cola</p> </td> <td> <p>PepsiCo</p> </td> <td> <p>Dr Pepper</p> </td> </tr> <tr> <td> <p>Forward PE</p> </td> <td> <p>16.06</p> </td> <td> <p>15.45</p> </td> <td> <p>12.92</p> </td> </tr> <tr> <td> <p>EV/EBITDA (ttm)</p> </td> <td> <p>13.91</p> </td> <td> <p>11.07</p> </td> <td> <p>8.44</p> </td> </tr> <tr> <td> <p>PEG Ratio</p> </td> <td> <p>1.95</p> </td> <td> <p>2.36</p> </td> <td> <p>2.00</p> </td> </tr> <tr> <td> <p>Dividend Yield</p> </td> <td> <p>2.70%</p> </td> <td> <p>2.90%</p> </td> <td> <p>3.50%</p> </td> </tr> <tr> <td> <p>Payout Ratio</p> </td> <td> <p>52.00%</p> </td> <td> <p>54.00%</p> </td> <td> <p>46.00%</p> </td> </tr> </tbody> </table>

We can see that Dr Pepper is trading at a discount to both Coca-Cola and PepsiCo and looks attractively priced on a PEG basis. Moreover, Dr Pepper provides the highest dividend at the lowest payout ratio. Thus, it certainly looks like a good investment opportunity.

We all know that Warren Buffett is a big fan of Coca-Cola and Coca-Cola shares accounts for around 20% of his total portfolio.  However, it’s not just Coca-Cola that has a high level of institutional ownership; both Dr Pepper and PepsiCo also enjoy significant levels of institutional ownership. The following table provides a summary of the percentage of shares held by institutions for all the above mentioned companies.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Coca-Cola</p> </td> <td> <p>PepsiCo</p> </td> <td> <p>Dr Pepper</p> </td> </tr> <tr> <td> <p>Institutional Ownership</p> </td> <td> <p>63.90%</p> </td> <td> <p>69.30%</p> </td> <td> <p>98.70%</p> </td> </tr> </tbody> </table>

Source: Yahoo! Finance

We can see that Dr Pepper has the highest level of institutional ownership. A high proportion of institutional ownership provides a support and stability to the stocks, as institutional investors are generally long-term investors. 

I think that negative sentiment around input costs and potential future competitive challenges with PepsiCo and Coca-Cola obscures the current reality of a strong, concentrated business that generates significant cash flow. In my view, Dr Pepper is well positioned in the more attractive beverage categories with relatively high growth profiles and margin; the company has a portfolio of strong brands across categories, which provides balance and potential upside from hidden gems; and strong free cash flow, cost savings opportunities, and a shareholder-friendly capital allocation philosophy should help optimize returns. In addition, additional cold drink assets and fountains provide significant multi-year growth opportunities. Hence, I rate it as a buy.

investorguide has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of PepsiCo. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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