Reasons to Trust Dr. Pepper
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The stock price of Dr Pepper Snapple Group Inc (NYSE: DPS) reached an all-time high this week. The company has been in the process of transforming itself since the split-off from Cadbury in 2008, and we see under-appreciated margin expansion opportunities over the next several years. Moreover, we see ample opportunity for the consistent generation of sizable free cash flow, the majority of which we expect will continue to be returned to shareholders through dividend increases and material share repurchases, given the absence of outsized M&A ambitions. Even though Dr Pepper is priced at the highest levels, we are positive that there is still some room for its share price to grow. The following are reasons that make us optimistic about company’s growth prospects.
RCI Savings Visibility Is Improving
Dr Pepper began rapid continuous improvement over a year ago; the company has identified over 160 Kaizen improvements, contributing $94 million of RCI savings to date. Because of the continuous improvement initiatives, Dr Pepper Snapple Group has reduced its inventory costs by $58 million lower than at the same time last year. On a daily sales basis, this is an improvement of eight days. Amidst continuous supply chain related improvements, the company has also closed ten warehouses, significantly reduced transportation costs, and implemented over 500 safety improvements. Going forward, the management seems to be on the right track in realizing $150 million in productivity savings through 2013.
Reduced Commodity Price Risk
We think the company has implemented most 2012 hedges at this point, so visibility is reasonably good. Packaging & ingredient costs are now expected to increase 2012 COGS by 2% on a constant volume/mix basis, vs. previous guidance of 2-3%. The company is increasingly hedging key commodities including PET, diesel fuel, HFCS, aluminum, sucrose, apple juice concentrate and natural gas. This has reduced a significant amount of risk posed by fluctuations in commodity prices. As a result, the company expects that a 10% change in key commodity prices would impact net income by approximately $9 million on an annual basis; a substantial improvement from the last year’s $32 million.
No Exposure to European Market a Big Plus in the Short-term
Despite not having a vast international exposure and growth opportunities as compared to other major beverage companies like Coca-Cola (NYSE: KO) and PepsiCo (NYSE: PEP), Dr Pepper is positioned well, as it does not have to deal with the ongoing European crisis. Dr Pepper is focused solely on North America and this is a huge benefit in the short-term, and also provides an excellent expansion opportunity in the future as the company's brands begin to cross the border under an easier macro environment.
Steady Shareholder Returns
During the second quarter Dr Pepper returned $293 million to shareholders, through share repurchases and dividends. Dr Pepper still has about $1.1 billion of authorized share repurchase programs remaining. Given the current cash balance and strong cash flow, we think there is a good upside potential to management’s guidance for 2012 share repurchases of $350-375 million.
Presently, the company’s presence is limited to United States, Mexico, and certain areas of Latin America. The company is working to increase its presence in the North America and thus, the potential to continuously expand offers exciting stock appreciation potential. And, despite trading at all-time highs, the valuation is still not as high; Dr Pepper’s forward P/E of 13.98 is at a 14-23% discount to its peer group of PepsiCo and Coca-Cola. Thus, there is still room for upward correction and we recommend it a buy.
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