Dr Pepper Stands to Gain from Impending Cola War
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
PepsiCo (NYSE: PEP) has been underperforming and recently investors have been clamoring for a spin-off of the company’s snack division so that it can focus on its soda. In their most recent earnings call CEO Indra Nooyi ruled out a break up but did announce a renewed focus on its flagship soda brands. Pepsi intends to pour between $500 and $600 million dollars into advertising and marketing its core soda brands, with a focus on North America, over the next year. This is a welcome change for Pepsi shareholders who have watched the share price languish while rival Coca-Cola (NYSE: KO) gained both market share and market cap. Last year Pepsi ceded the number two soda spot to Diet Coke in the US and has continued to lose market share.
Where does Dr Pepper Snapple Group (NYSE: DPS) come in to play? It occupies third place and stands to benefit tremendously from Pepsi’s renewed focus on soda. Dr Pepper expects Pepsi’s advertising spree to lift the entire soda market, particularly in the US, where soda volumes have been shrinking for decades. During their recent earnings call CEO Larry Young even said as much, remarking “I get very excited when I see the competition spend more on marketing. That’s good for the industry.”
Dr Pepper has also announced marketing changes of its own, shifting from national to local venues in an effort to spend more effectively. They also will be focusing on social media and the growing Hispanic demographic in an effort to increase efficiency. If Pepsi’s renewed focus on soda is successful, Dr Pepper’s shift toward targeted advertising could be magnified. Dr Pepper has already seen some success with its Dr Pepper Ten advertising, which targets men. The company correctly recognized diet drinks for men as an underserved market and this recent quarter showed strong results for the new offering. Volume for its namesake line, which includes Dr Pepper Ten, was up 2%, while volume for the remaining brands was down 6%.
The secondary brands are much more of a worry, particularly 7 Up, Crush, and Sunkist, which all experienced double-digit drops in volume for the most recent quarter. To address this issue, the company has begun work on Ten versions of their other offerings in an effort to shore up volumes. They have developed five brands to test including recent underperformers 7 Up and Sunkist. 7 Up Ten, Sunkist Ten, A&W Ten, Canada Dry Ten, and RC Ten began testing January of this year. If the new versions of Ten are well received, Dr Pepper stands to gain tremendously.
As I mentioned earlier, soda volumes have been declining for decades in the US and it is a serious issue when coupled with increasing input prices. Last year packing and ingredient costs climbed nearly 9% and put significant pressure on the industry. Dr Pepper expects a more manageable rise in input costs this year, in the range of 2-3%, but it remains an issue. However, there is a bright side to the increased costs: Nobody is in a position to start a price war. As the smallest of the three, this helps keep the playing field even for DPS and gives it some breathing room.
Admittedly, Dr Pepper lacks the global footprint of its competitors but this is a domestic story. Both Pepsi and Coke have significantly larger international operations; if Pepsi’s plan does lift soda sales across the board in North America, the gains will be most noticeable for Dr Pepper.
Dr Pepper is poised to benefit from the increased attention Pepsi will bring to the market. The company has also proved it can take advantage of its assets and grab market share. As a Carolinian I was excited to see them take Sun Drop national and more importantly, it has been a success. According to Dr Pepper Sun Drop is now the number 2 brand in the citrus category. The company already has a strong non-soda presence and is continuing to make moves to strengthen that. Assuming input pressures moderate, I’m bullish on all three, but I suspect Dr Pepper Snapple Group will pop a bit more in the coming months.
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