Why This Beverage Company Is Good, but Not Great

Investors should look beyond near-term financial results when evaluating an investment. While Dr Pepper Snapple recently delivered good quarterly results, it isn't well positioned for the future.

May 1, 2014 at 5:47PM

Source: Dr Pepper Snapple

As the third largest refreshment beverage company in the U.S., Dr Pepper Snapple (NYSE:DPS) has a strong brand portfolio which comprises six of the top 10 non-cola soft drinks and 13 brands which are among the top two in their flavor categories. These include leading beverage brands such as Dr Pepper, Snapple, 7UP, and Mott's. In the first quarter of 2014, Dr Pepper Snapple delivered an outstanding set of results, growing quarterly core EPS by 40% year-over-year.

Does this make Dr Pepper Snapple a good investment candidate, and how does Dr Pepper Snapple compare with other beverage companies such as Coca-Cola (NYSE:KO) and Monster Beverage (NASDAQ:MNST)?

Lagging peers in terms of profitability
In addition to a strong first quarter financial performance, Dr Pepper Snapple also did well in 2013.

Notwithstanding declining sales of carbonated soft drinks (CSDs) in the U.S., Dr Pepper Snapple gained market share of 0.1% in the U.S. CSD market along with peers Coca-Cola (+0.4% market share) and Monster Beverage (+0.2% market share) in 2013.

With respect to 2013 CSD sales volume, Dr Pepper Snapple and Coca-Cola both outperformed the overall industry by posting volume declines of 2.4% and 2.2%, respectively. This is compared to a 3% drop in U.S. CSD market. Energy drinks company Monster Beverage did even better, growing CSD volume by an impressive 7.7%.

While Dr Pepper Snapple's leading brands have allowed it to outperform the CSD industry as a whole, its profitability still lags that of peers. Coca-Cola's and Monster Beverage's five year (2009-2013) average operating margins of 23.1% and 27%, respectively, are significantly higher than that of 18.1% for Dr Pepper Snapple. There are different factors at play contributing to Dr Pepper Snapple's inferior margins.

In comparison with Coca-Cola, Dr Pepper Snapple' scale and distribution model put it at a disadvantage. Firstly, Coca-Cola's revenues are more than seven times that of Dr Pepper Snapple, giving it significant economies of scale. Secondly, Dr Pepper Snapple is dependent on third-party vendors to distribute its products to retailers. In contrast, Coca-Cola operates on a direct selling model that gives it greater leverage over retailers.    

Comparing Dr Pepper Snapple with Monster Beverage is a case of pitting flavored sparkling drinks against energy drinks. While flavor and taste are very subjective factors in determining the choice of a drink, energy drinks provide consumers with tangible benefits like a caffeine boost.

This suggests that demand for energy drinks is more inelastic. This is supported by a 2011 New Nutrition Business survey which shows that energy drinks cost about four time as much as regular Coca-Cola-branded soft drinks on a price-per-liter basis.

Img Lets Play
Source: Dr Pepper Snapple

No presence in growing beverage segments & markets
While Dr Pepper Snapple's brand portfolio is diversified with more than 50 brands and hundreds of different flavors, it isn't positioned in the growing beverage segments and markets.

Geographically, Dr Pepper Snapple is very much a domestic company with a substantial portion of its sales derived from the U.S. and Canada. Only about 7% of its 2013 revenues are generated from Latin America.

In contrast, Coca-Cola is a global company with operations in every continent, and more than half of its sales coming from outside North America. Foreign operations also contributed about a quarter of Monster Beverage's 2013 top line. As North America is already a mature market for beverages, Dr Pepper Snapple's domestic focus means that its growth prospects are less exciting than that of its peers.

Unlike its peers, Dr Pepper Snapple doesn't have exposure to high growth beverage segments such as energy drinks and liquid enhancers. As the world's second-largest energy drink company, Monster Beverage is the best proxy for the growth in the energy drinks category.

On the other hand, Coca-Cola has shown a willingness to capitalize on new consumer trends with the introduction of its liquefied drink enhancer Dasani Drops in 2012. As more consumers have their beverages on the go, liquid enhancers will gain greater popularity.

Foolish final thoughts
Taking into account the general decline in the U.S. CSD market, Dr Pepper Snapple's performance has been satisfactory. However, it is less profitable than its peers and doesn't have sufficient exposure to growing beverage segments and markets. As a result, Dr Pepper Snapple is a less attractive beverage company investment than its peers.  

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Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola. The Motley Fool owns shares of Coca-Cola and Monster Beverage and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. 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.

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