Dr Pepper Faces Tough but Doable Task With Coca-Cola and PepsiCo

Dr Pepper Snapple Group (NYSE: DPS  ) reported volume declines and meager revenue growth when it released its third-quarter earnings last week. The weakness is symptomatic of a larger trend in the industry. The carbonated soft- drink category has been plagued by health concerns over the drinks' link to obesity and diabetes, among other health issues. Growing consumer awareness about the health risks, in addition to the proliferation of healthier options, has put significant pressure on North American soft-beverage companies.

Nowhere to hide
Unfortunately, the company's struggles this year are likely to persist. Dr Pepper Snapple previously relied on diet extensions to its popular brands to offset weak overall soft-drink sales in North America, but even diet soda is under attack from nutritionists. Artificial sweeteners included in the diet beverages, such as aspartame and high-fructose corn syrup, as low-calorie replacements for traditional sugar are increasingly frowned upon by consumers due to perceived health risks.

Dr Pepper Snapple is not the only company experiencing trouble in the diet soda category. Coca-Cola (NYSE: KO  ) and PepsiCo (NYSE: PEP  ) have also struggled among the consumer backlash. BevNET reports that all three companies have experienced high-single-digit percentage declines in the troubled category.

According to a recent Beverage Daily article, Dr Pepper Snapple CEO Larry Young blames the diet soda volume weakness on consumer misconceptions about artificial sweeteners, but the larger trend in the United States and Canada suggests that the problem may be more permanent than a simple misunderstanding. Americans and Canadians are embracing healthy and natural foods at a high rate, and there is nowhere for large soda companies to hide.

Coca-Cola and PepsiCo are relatively better positioned for American consumers' secular shift away from carbonated soft drinks. Both companies have a large presence in emerging markets -- the prime source of growth in the industry. Meanwhile, Dr Pepper Snapple is concentrated in the United States and Canada, neither of which is an outlet for growth. As a result, Dr Pepper Snapple expects no year-over-year revenue growth in 2013.

Dr Pepper Snapple is also a distant third to Coca-Cola and PepsiCo in North American market share. Coca-Cola maintains a 40% share of the market, PepsiCo a 30% share, and Dr Pepper Snapple a 16% share. Moreover, Dr Pepper Snapple has increased its share of the market by just two percentage points in the last decade -- hardly a pace that will make up for slowing industry growth.

Dr Pepper Snapple can only keep growing if it increases per-capita consumption of its products. This will not be easy, especially with all of the negative media surrounding carbonated soft drinks, but its competitors are focusing their energy elsewhere so there may be an opportunity for Dr Pepper Snapple to increase its brand presence in North America.

The company has a portfolio of strong brands. According to Morningstar, 75% of Dr Pepper Snapple's volume comes from brands that are No. 1 or No. 2 in a category. This makes it likely that the company will be able to compete for consumer dollars even as the carbonated soft-drink market deteriorates.

Bottom line
Coca-Cola will continue expanding its carbonated soft-drink business in emerging markets, PepsiCo will leverage its Frito Lay division to offset weakness in the domestic carbonated soft-drink market, and Dr Pepper Snapple will attempt to grow per-capita consumption of its top brands to pick up market share in a tough domestic market. Each company has a different method of coping with the industry's struggles in North America, but none has an impossible task at hand.

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