Last Thursday, Monster Beverage (NASDAQ:MNST) lost 14.4% in a single trading session, after it released its fourth-quarter 2017 earnings results. The company posted 7.5% revenue growth, a relatively tame result, which it blamed partially on inventory reductions by bottling partners in Europe, Chile, and Japan.
Management estimated that the inventory draw-downs may have squeezed as much as two percentage points from top-line growth during the quarter. But that's only an educated guess, as the company must rely on distributors' own estimates of ending inventory levels of Monster products. Monster sells primarily to bottling companies and third-party distributors, although it does engage in some direct retail-channel distribution. During last week's conference call, CEO Rodney Sacks hinted that preliminary data showed some rebound in distributor levels in January.
As Monster's stock swooned on the 1st of March, my Foolish colleague Anders Bylund made an astute observation:
At this point, Monster hasn't delivered a positive earnings surprise since the first quarter of 2016. The stock has still delivered a market-beating 32% return over the last 52 weeks -- a period including four earnings misses and today's big drop.
I really like this point because it illuminates the paradoxical thinking that can sometimes inform the market pricing of growth stocks. Widely used models of stock valuation, such as the Capital Asset Pricing Model, or CAPM, predicate that investors should expect a higher rate of return from volatile stocks (those that sport a steep beta) versus those that are correlated more closely to the overall market.
So, the more the risk inherent in a stock (as measured by its beta coefficient), the higher an investor's required rate of return to compensate for that risk.
Risky companies with growth potential justify their steeper valuations over time through steady, rapid earnings expansion. But repeated stumbles on earnings dates tend to have the opposite effect, depressing the stock price of such companies, as investors reassess long-term growth rates and temper their expectations for return.
And yet sometimes, the very lack of earnings visibility is seen by investors as an expression of a company's potential over a stretched-out time frame. I believe this phenomenon is supporting Monster's current share price.
The long and arduous road of global investment
Monster is being judged on its multiyear potential to expand global sales, pursuant to its 2015 partnership agreement with the Coca-Cola Company (NYSE:KO) In this transaction, Monster received Coca-Cola's entire energy-drink portfolio, while agreeing to use Coca-Cola's global bottling partners and distribution system to expand.
Indeed, the company has ramped up global sales in recent years. Gross sales outside the U.S. reached $1.1 billion in 2017, an increase of 23% over the prior year. This mark is 67% higher than the $658 million of non-U.S. sales Monster recorded in 2014, the year before its Coca-Cola transaction.
In case we forget how long it takes to tack on distribution throughout the globe, going country by country, here's a synopsis of Monster's current launch activity provided by management. In the fourth quarter of 2017, the company began distribution of its namesake Monster Energy beverage through Coca-Cola bottlers in Ghana, Morocco, the Bahamas, and Grenada. First-quarter 2018 launches of Monster Energy via Coca-Cola bottlers include Armenia, Belarus, and Tanzania. And during the first and second quarters of this year, the company will introduce Monster in important Latin American markets, including Argentina, Ecuador, and Uruguay.
The gradual scaling into Coca-Cola's network makes it difficult to predict revenue from quarter to quarter. Monster itself doesn't have an extremely fine sense of the inventory levels different distributors will end up with at the end of each period, especially as it tries to get a sense of seasonal depletion rates for each new partner. This kind of muscle memory can take a few years to build.
But Monster can illustrate growth for investors by examining its products' retail sales in the open market. In other words, once distributors place beverages on store shelves, how do Monster's labels fare? Sacks spent several minutes on Thursday's conference call reading independent measurements of Monster's retail-channel sales and market-share improvements in 21 different countries. Nearly all of these were positive, in some instances showing sales acceleration in the double digits, with Monster taking share from competitors like Red Bull GmbH in several countries. Consumer demand for Monster's lineup remains compelling.
To return to Anders Bylund's paradox: Owners of Monster shares are investing on uncertain information in the near term, as the company builds out infrastructure with Coca-Cola partners in innumerable geographic regions. This type of growth is different from the linear expansion a young software company (for example) might exhibit. In the tech world, quarterly metrics like increases in total subscribers to a cloud service, or average volume per user, don't admit quite as much ambiguity.
Last week's results pressured Monster stock. But if recent patterns hold, profit-taking will be followed by a stable or rising stock price, as investors return to their broader investment thesis on Monster Beverage. In the absence of smooth results, retail and institutional investors have focused, quite Foolishly, on Monster's long-term potential.