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For most companies, there are only a handful of key factors that determine shareholders' return. Dr Pepper Snapple Group (NYSE: DPS) is no exception. Although it faces stiff competition from Coca-Cola (NYSE: KO) and PepsiCo (NYSE: PEP), Dr Pepper's future stock price will be determined by its ability to focus on the three strategic factors outlined below.
(1) Hispanics are key to Dr Pepper's growth strategy
According to a report by Coca-Cola, Mexico is the largest per-capita consumer of carbonated soft drinks in the world. Moreover, Dr Pepper has discovered that Hispanics prefer flavors (such as Sunkist soda) to colas. This presents an enormous opportunity for the company as the Hispanic population continues to grow in the United States.
Dr Pepper is capitalizing on the favorable demographic trends in several ways. First of all, its California "Latino Street Force" sales team is raising awareness of the company's brands at community events and Hispanic businesses. Its efforts to connect with the community have enabled Dr Pepper to gain more prominent display space in stores frequented by Hispanics.
More broadly, Dr Pepper's TEN products target people who want full flavor but fewer calories. This appeals to Hispanics who want flavor, millennials who want variety, and men who do not drink diet colas. The TEN product line is critical to the company's goal of increasing per-capita consumption among Hispanics and attracting customers that would not otherwise drink carbonated soft drinks.
In a pilot study performed by Dr Pepper, the company discovered that 55% of the people who bought TEN products did not previously drink carbonated soft drinks. If a similar percentage of non-carbonated soft-drink consumers adopt the TEN products nationwide, Dr Pepper has an enormous growth opportunity.
(2) License agreements with Coca-Cola and PepsiCo
Many people do not think about the logistics of distributing millions of caseloads of soft drinks to stores throughout North America, but it is an important part of the business. Distribution requires a large fleet of trucks that deliver products to stores and complex computer systems to optimize delivery. In short, it is extremely expensive to build a distribution network, so Dr Pepper largely relies on third-party distributors.
Two of the company's primary distributors are rivals PepsiCo and Coca-Cola. PepsiCo paid Dr Pepper $900 million for the right to distribute the company's products in North America through 2030. Coca-Cola paid $715 million for the right to distribute products in the United States and Canada, but also gives Dr Pepper access to its fountain accounts.
The benefit of allowing PepsiCo and Coca-Cola to distribute the company's products is clear: instead of having to build and maintain an expensive distribution network, Dr Pepper can invest in marketing and return capital to shareholders. Unfortunately, there are also drawbacks to these arrangements. Beverage Daily cites analyst Bonnie Herzog's concern that PepsiCo and Coca-Cola are not promoting Dr Pepper like they would their own brands.
She says, "[Dr Pepper] has limited control over its [Dr Pepper TEN] brand and in-store experience...[yet] in-store product displays are one of the most effective means of driving purchases." In other words, the TEN brand is suffering because Dr Pepper is not able to micromanage its product displays. Dr Pepper needs to find a solution quickly.
(3) Dr Pepper returns most of its free cash flow to shareholders
A wonderful byproduct of not having to maintain an expensive distribution system is that Dr Pepper has relatively low capital expenditures. Dr Pepper's capital spending is just 2.4% of annual revenue. By contrast, PepsiCo's PP&E expenditure is 5% of revenue and Coca-Cola's is 3.2%.
As a result, the company is able to return a large amount of cash to shareholders. The company increased its dividend for the fifth consecutive year in 2013 and has ample free cash flow to continue raising it. Moreover, Dr Pepper used the $1.6 billion earned from the PepsiCo and Coca-Cola distribution agreements to repurchase stock in 2010 and 2011 at favorable prices. As a result, the company has reduced its share count by 18.5% since 2010.
Although the company will not be able to repurchase as many shares going forward, it remains committed to returning the lion's share of free cash flow to shareholders.
Remember the three keys
Investing is simple; there are only a few key factors that really matter in any given investment. For Dr Pepper, the keys are (1) its popularity with the Hispanic population and its TEN products, (2) its ability to improve in-store execution by its distribution partners, and (3) its continuing commitment to return capital to shareholders. Investors should monitor these three things to ensure the company is moving in the right direction.
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