This Is Becoming A Bad Habit

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

In just a few weeks Monster Beverage (NASDAQ: MNST) should release earnings, and investors appear worried. In the last few months, the stock went from $56 a share to under $48 as of this writing. What's ironic is this roughly 14% drop corresponds almost perfectly to the 14.5% earnings miss the company turned in last quarter. With earnings coming up, there are a few things investors need to pay close attention to.

Monster Beverage of course owns the Monster and Peace Tea brands, among others. In the past, I've written that the company was perfectly positioned because energy drinks and pre-packaged tea sales have been two of the three strongest performing beverage categories. It's well known that consumers are switching away from traditional sodas, and the growth in still beverages has actually been a driving force behind Coca-Cola (NYSE: KO) for several quarters.

Another competitor, PepsiCo (NYSE: PEP), has seen its earnings stagnate in no small part due to the fact that the company can't seem to generate volume growth in beverages on a consistent basis. The same can be said of Dr. Pepper Snapple Group (NYSE: DPS), which ironically has intently focused on promoting its soda lineup at a time when the market seems to be moving away from this category. What all of these companies have in common is they are constantly looking for a way to grow volumes, and in turn grow profits.

The beverage industry is expected to grow by just 2.6% in 2013, yet energy drink volume growth has been solidly in the double digits for several years. However, there are some that predict that the U. S. energy drink market may have reached saturation because of a lack of innovation. In addition, there seems to be a stigma attached to some energy drinks that puts off many adult consumers. A survey from just a few years ago found that 74% of those surveyed didn't consume energy drinks, and 69% were not interested in trying them. However, this same research found that if a promotion was offered, consumers would be willing to try the product.

Promotional expenses should be the most watched item in Monster's upcoming earnings. In the prior quarter, the company reported net sales up 14.2%. However, promotions and allowances rose from 13.39% of sales to 14.29%. The challenge for Monster is their ability to offer enough promotions to spur volume growth without hurting earnings. The company had trouble striking the right balance last quarter, with EPS growth of just 6.1% even though case sales were up 18%. If you look at most of Monster's large competitors, they would love to see 18% growth in case sales, but I doubt they would offer such a high percentage of promotions.

Coca-Cola has nearly matched Monster's volume growth rate with their Full Throttle brand, which has shown growth in the high teens or better. The company's Gold Peak and Honest Tea brands have seen 13% growth while competing with Monster's Honest Tea brand. Though Pepsi holds the iconic Mountain Dew brand, the company has consistently reported low single digit declines or increases in beverages. Given that Pepsi also bottles multiple brands of tea, it's somewhat surprising that the company hasn't been able to match Coca-Cola or Monster's volume growth rates.

Unfortunately for Dr. Pepper Snapple investors, the company just isn't playing in the same league. In their last quarter, Dr. Pepper Snapple saw overall volumes down 3%, and non-carbonated beverages performed even worse with a 5% decline. Dr. Pepper Snapple's lack of focus around promoting their still beverage lineup seems like a big mistake. What there is no mistake about is, Monster's margins are better than their competition, but this seems at risk as well.

In their recent quarter, Monster reported an operating margin of 26%, but this was down from 27.8% last year. With Coca-Cola reporting a margin of 22.63%, Pepsi at 16.81%, and Dr. Pepper Snapple at 20.16%, the out performance of Monster is obvious. Investors need to watch the company's margins carefully; if Monster continues to see a decline in margins this could mean the company is sacrificing pricing for volume. Since high volumes combined with higher prices lead to Monster's tremendous growth, any weakening of margins is a red flag.

Last but not least, investors need to watch the bottom line EPS number. Monster has gotten into a bad habit and missed EPS projections in three of the last four quarters. If Monster misses estimates, this brings into question analysts projections of 19% EPS growth in the next few years. If the company meets expectations for the year, the stock sells for about 20 times earnings. If they continually miss estimates, that projected P/E number goes up.

The bottom line is that Monster appears to be gaining volume at the expense of pricing. If this continues, lower margins and reduced earnings will become the norm. Considering that Coca-Cola is seeing good volume growth in their still beverages, and the stock pays a 2.75% yield that Monster can't match, investors may start to question why they own Monster. While Pepsi and Dr. Pepper are secondary choices to Coca-Cola or Monster, their yields of about 3% and more established franchises may lure some investors away as well. This is a pivotal quarter for Monster. If they can reverse last quarter's issues, the growth story continues. If not, the decline may be down right scary.

MHenage 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!

blog comments powered by Disqus