Pick a Different Pepper

By Chad Henage - July 16, 2012 | Tickers: KO, DPS, MNST, PEP | 0 Comments

• Email
• Print

In a recent article on The Motley Fool, Brian Pacampara looked at Dr Pepper Snapple Group (NYSE: DPS). In summary, what he found was that 93% of CAPS members believe that the company will outperform the market averages going forward. The two primary reasons for this belief are, the company's 3.1% dividend yield, and the fact that soft drinks and non-carbonated beverages tend to be fairly recession proof industries. While Brian acknowledged that Dr Pepper is in third place behind Coca-Cola (NYSE: KO) and PepsiCo. (NYSE: PEP), CAPS members believe that even third-place is good enough in this industry. Call me a skeptic, but I honestly don't see how third-place can be good enough, considering Dr. Pepper's competition.

To get an idea of the relative strength of each of the major players in the industry, let's compare how Dr Pepper stacks up to Coca-Cola, PepsiCo., and Monster Beverage (NASDAQ: MNST).

(cash flow calculated from net income + depreciation – capital expenditures from last full year then compared to full year sales) 

To be honest, in the soft drink industry if you're choosing Dr Pepper, you're seeing something I'm not. The fastest growing segments in the industry are bottled water and teas, as well as energy drinks. As an example, in Coca-Cola's last earnings release, the company reported a 15% increase in packaged water sales, a 10% increase in teas, and a 25% jump in energy drink sales. Just by reading the name brands that Dr. Pepper owns in these faster growing categories, you know there's a problem. The brands in water, tea, and energy drinks are: Dejablue, Penafiel, Snapple, and Venom.

I know everyone has heard of Snapple, but when was the last time you heard someone trying to pick out water saying, "now where is that darn Dejablue?" The answer is never. In the bottled water space, Coca-Cola has Dasani, and Pepsi has Aquafina. These two brands dominate the space along with Deer Park, which is owned by Nestle. When it comes to teas, I'll grant that Snapple has a good brand name, but the tea category is more fragmented, and is the third fastest growing segment behind energy drinks and bottled waters.

Speaking of energy drinks, the clear growth leader in this industry is Monster Beverage. While analysts expect earnings growth of 15% longer-term, I believe that analysts may be underestimating Monster's growth potential. Just as an example, analysts are looking for revenue growth of over 25% this year and nearly 17% next year. I'm not sure why 25%, and 17% revenue growth, would turn into only 15% earnings-per-share growth. The fact that analysts have also raised full-year estimates for this year by over 6%, and next year by over 9%, shows that the company is outgrowing analyst expectations already. This category is all about brand awareness, and Dr. Pepper's Venom isn't even playing on the same field as Coke's Full Throttle or Pepsi's AMP products. Since even Coke and Pepsi are having trouble dominating this market, you can see that Dr. Pepper is fighting an uphill battle. What should be even more disconcerting to Dr. Pepper investors is, the company knows that it has a lower exposure to energy drinks. The company only mentions Venom (it's primary brand) once in its last annual report. When one of the category leaders (Monster), is growing like wildfire, and Coca-Cola is seeing 25% increases, Dr. Pepper's avoidance of this category is a red flag for future growth. The fact that Monster canceled their bottling agreement with Dr. Pepper in favor of Coca-Cola also tells you something about Coca-Cola's distribution and manufacturing network versus Dr. Pepper. With these challenges, what is an investor to do? 

If you're an investor looking for income, PepsiCo and Dr Pepper's yields are nearly identical, yet PepsiCo has a huge track record of dividend increases. The leader in the field without question is Coca-Cola. While Coca-Cola's dividend yield is slightly less, the company's growth rate is better than either Dr Pepper or PepsiCo. In addition, the company has shown a willingness to increase its dividend at a relatively high level for a long time.

Given this information, if you're looking for dividend yield, I would choose Coca-Cola. You give up a little bit of yield, but you gain a faster growth rate, and a better dividend track record. If you're an investor looking for growth, or not as concerned with current income, Monster Beverage could be a good choice. Only Monster comes close to generating the same amount of free cash flow per $1 of sales compared to Coca-Cola. Monster has the best expected growth rate as well. While on the surface Monster looks to be the most expensive stock, this is slightly misleading, as Coca-Cola actually sells for a higher PEG ratio than Monster. At this point, no matter how you cut it, Dr. Pepper doesn't seem like the best choice. Usually I can agree with CAPS members, however in this case we're going to have to agree to disagree. 

• Email
• Print
• Feedback