This Monster Is Returning From The Dead

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

Soft drink giants Coca-Cola Company (NYSE: KO) and PepsiCo (NYSE: PEP) have duked it out for decades for single digit percentage points of market share but a monster is creeping up behind them with a stranglehold on a growing niche beverage market.

Since 2005 soda sales have been slipping and both companies scrambled to find alternative still and sparking beverages with Coca-Cola being the more recalcitrant of the two. It lost Gatorade to PepsiCo thirteen years ago.

Both were reluctant to get into small segment niches as they were the big dogs, global and dominant. Meanwhile, you probably already know the story, a small natural beverage company, Monster Beverage (NASDAQ: MNST) came out in 2002 with its first energy drink. The stock took off and has rarely looked back. Until this year, that is.

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MNST Total Return Price data by YCharts

The chart shows me that Coca-Cola and PepsiCo's storied rivalry has held them back, so intent to gain share against the other that they have practically traded in lockstep.

Their focus on soda and defending the beverage against on onslaught of negative public opinion and  proposed soda bans hasn't stemmed the trend to decreasing consumption year after year.

Even after the monster gains at Monster neither of the big soda companies have supported their energy drinks with much promotion or marketing instead trying to bump up diet soda sales by trying alternative sweeteners like stevia. That hasn't worked so well as diet soda sales have also declined according to The Wall Street Journal.

All three companies carry different kinds of beverages: carbonated beverages, ‘functional’ beverages, and teas, juices, water and ades collectively called ‘stills.’ The functional provide a benefit like rehydration , vitamin-enhanced,  pre and probiotic drinks for digestion, and energy drinks.

In the energy drink space the prime position is still held by privately held Red Bull which sold $2.9 billion worth of the drinks in 2012. Closely following was Monster which sold $2.6 billion of energy drinks and lagging far behind were the energy drinks Amp (PepsiCo) at $300 million, and Coca-Cola's Nos and Full Throttle at $250 and $140 million, respectively.

Market Line reports that globally, energy drinks comprise 58% of market share of functional drinks (sports drinks and energy drinks) with global sales of $39 billion by 2014. While PepsiCo is the acknowledged leader in sports drinks with its Gatorade, Monster is the publicly traded leader in energy drinks.

The dog ate my homework and other excuses

Coca-Cola reported disappointing Q2 earnings on July 16 blaming the weather. While usually that excuse is as lame as the dog ate my homework this time other beverage companies like ImBev, the giant beer company, also claimed weather impact on sales. Coca-Cola reported EPS of $0.59 down from $0.61 in Q2 2012 and revenue declined to $12.75 billion.

Although Coca-Cola is one of Warren Buffett's largest holdings its P/E is high at 21.51 and the yield is 2.70%. The PEG is the highest of these at  2.46.

PepsiCo's earnings were better with their snack and food division offsetting decreasing soda sales. They also reported good numbers in emerging markets where soda sales haven't declined as in the US, especially in Asia, Middle East, and Africa with a 14% gain in organic revenue.

CEO Indra Nooyi said, "Importantly in the second quarter, we increased both gross margins and operating margins by more than 100 basis points."

The company also guided for 7% core constant currency EPS growth for 2013 and reaffirmed $6.4 billion would be returned to shareholders in the form of dividends and buybacks. PepsiCo has a yield of 2.60%  and trades at a 21.92 trailing P/E with a 2.30 PEG.

Initiatives for this year include the rollout of Farmstand, a fruit-vegetable juice line from Tropicana. This is expected to be one of PepsiCo's biggest product launches since 2009 and adds to their growing portfolio of still beverages that are more nutritional and functional. Activist investor Nelson Peltz  has  been pushing  the company for a possible buyout of international snack company, Mondelez International. It would seem Coca-Cola needs Mondelez more. Monster itself has long been rumored as a buyout target for one of the big soda companies.

The return of the monster

Despite a runup of 77% from July 2011-2012, this last year Monster stock has dropped 7.23%. It has no debt and operating cash flow of $296.8 million. The company has a lofty trailing P/E of 34.67 but that has come down from 43.44 last summer and the forward P/E comes down to 25.42.  The PEG is the lowest of these three at 1.91.

The short interest has grown from last summer at under 1% to over 5% partly due to continuing controversy over energy drinks' safety with a Maryland lawsuit underway concerning the death of a 14 year old girl who died after drinking Monster drinks. It was later found she had an underlying heart condition. Also, the city of San Francisco is suing the beverage maker for marketing to children.

A major reason for share price decline is a decline from last summer's quarterly earnings growth rate of 38.30% yoy to -16.60% and missing bottom line expectations for three quarters.  Part is attributable to increased legal and travel expenses, costs associated with international expansion, and  promotion of new Monster products, like the very popular vanilla protein shake.

However, both Stifel Nicolaus and Sun Trust believe the stock will start to climb again. Sun Trust gives it a Buy with a price target of $75 arguing improving margins, decreasing headline risk, and easing comps. Analysts estimate a 15% five year EPS growth rate but with these international expansions and new products it may be higher going forward.

The Foolish takeaway

Monster is reporting on August 7.  Expenses should come down over the next few quarters and with kids back in college soon expect more consumption. The global expansion and new products are good news while competitors Coca-Cola and PepsiCo  underestimate  and underpromote their energy drinks.

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AnnaLisa Kraft has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, Monster Beverage, and PepsiCo. The Motley Fool owns shares of Monster Beverage and 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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