Monster Beverage (NASDAQ:MNST) issued second-quarter 2018 earnings results on August 8. The energy-drink pioneer reported record quarterly net revenue that crossed the billion-dollar mark for the first time, landing at $1.02 billion. Profitability was pressured by a 320 basis-point decline in gross margin, however, and was one of the significant points that company management discussed with analysts on Monster's quarterly earnings conference call.
Let's review the essentials on this topic, as well as two other key exchanges from Wednesday's discussion, directly below.
1. Numerous factors are squeezing margins
...[T]here's also been a switch between the proportion between strategic brands which have concentrated models, [and] higher margins; and Monster. And Monster is continuing to grow ahead of the strategic brand, so that continues to put some pressure on the margin as well.
-- CEO Rodney Sacks
CEO Rodney Sacks' comments followed a more specific list of gross operating profit headwinds enumerated by CFO Hilton Schlosberg. These included rising aluminum import costs due to tariffs enacted by the Trump administration, increased promotional spends due to higher cooler placement fees and shelf costs, rising sales of lower margin coffee-based beverages, and climbing international sales, which are slightly less profitable than their domestic counterparts.
The year-over-year decline of approximately 3 percentage points in gross margin (from 64.3% in the prior year to 61.1%) was the primary factor behind a 3.4 percentage-point dip in operating margin, from 38.6% in the second quarter of 2017 to 35.2% in Monster's most recent quarter.
In the last sequential quarter (Q1 2018), management expressed uncertainty over the impact of the numerous factors responsible for current-year margin compression. At the time, I wrote that absent concrete projections on margin, investors were turning cautious on Monster stock.
As a matter of policy, Monster avoids forward margin guidance. However, in the current call, CFO Schlosberg provided a more definitive reading, indicating that gross margin would settle in the 61% to 62% range over the next few quarters. This easing of investor concerns stems, in part, from an action we'll discuss in the next section.
2. Price increases will absorb rising costs
We are planning for approximately a 4% increase in our pricing to our customers effective November 1, 2018, for Monster and January 1, 2019, for NOS and Full Throttle... the price increase I referred to is related to the U.S.
-- CEO Rodney Sacks
The price increase should cover increases in input costs and the increases in freight. But who knows where they're going to go from there... I mean, today aluminum shot up again based on a number of factors. So as we sit here now, the pricing should contain our cost increases. Will we get more? I don't know, and I honestly I wouldn't consider even discussing more on this call because it's just too premature
-- CFO Hilton Schlosberg
Of the various profitability pressures Monster is currently enduring, rising input costs (particularly in aluminum), as well as higher shipping costs can be addressed by price increases, as the company's products enjoy inelastic demand at marginal price hikes. This means that Monster's loyal customers probably won't flinch if the cost of their favorite energy drink bumps up by a handful of percentage points.
Pricing power in the beverage industry typically wins points with investors. That's because price adjustments rarely revert to prior levels -- with the exception of promotional discounts -- leading to even higher revenue as volume picks up.
Yet, as Schlosberg warns, investors shouldn't conclude that some of the price increase will end up boosting gross margin. Rather, this is a move to stabilize margin. As the CFO implies, given the volatility of aluminum spot pricing, there's no guarantee that the current price hike will even fully cover higher future costs.
3. Meaningful investment in Asia will occur over the next few quarters
With regard to China, we've just really focused on the top cities... [We] have some plans to expand the product line with an additional launch next summer early in 2019... It'll help us, we think, get visibility for our brand on the shelves, which is one of the things we've referred to in earlier calls. It's been hard for us to have a smaller-sized can and get recognized with a single can in stores, and particularly in Coke coolers where some of the Coke products have similar size cans.
So, we believe that the additional products will continue to help build the brand. So we're pretty positive on the build in China, but it is going to be a long, slow build. But ultimately, we think that the brand is going to continue to do well.
-- CEO Rodney Sacks
One of the most persuasive reasons to buy Monster Beverage shares lies in the company's long-term potential as it works to expand its global presence through the Coca-Cola Corporation's network of bottling partners. As I've recently discussed, this is a years-long effort and often entails creating energy beverage demand from the ground up in countries where energy drinks still are a nascent category.
Such is the case in China, and for that matter, India. Both countries are set to be a primary focus for Monster for the foreseeable future. Between them, they account for roughly 36% of the entire global population.
During the earnings call, CEO Sacks observed that the company launched its namesake Monster brand in India in April and aims to complete a nationwide rollout this year. As for the importance of this market, Sacks stated: "Hilton and I are both planning to go to India and review the markets and launch this ourselves personally within the next few months."
For shareholders, there's a primary counterpoint to the potential in Asia, however. Currently, Asia-Pacific sales make up just 6% of total company net revenue. As you can glean from Sacks' words above on the "long, slow build" of the brand in China, that counterpoint is patience.