Newly minted beverage giant Keurig Dr Pepper (NYSE:KDP) issued its first earnings report following the merger of Dr Pepper Snapple Group and Keurig Green Mountain in July 2018. The business combination created the third-largest beverage company in North America, with projected annual revenue of $11 billion. Let's dig into the third-quarter 2018 filing, released Nov. 7, to get a sense of how the combined operation has initially fared. Note that all comparative numbers in this article are drawn from the company's adjusted pro forma schedules. In other words, prior-year results of Dr Pepper Snapple Group and Keurig Green Mountain have been combined, with certain adjustments, to facilitate an apples-to-apples comparison with current earnings.

Keurig Dr Pepper: The raw numbers

Metric Q3 2018 Q3 2017 Growth (YOY)
Revenue $2.86 billion $2.78 billion 2.9%
Net income $301 million $253 million 19%
Diluted EPS $0.21 $0.18 16.7%

Data source: Keurig Dr Pepper. EPS = earnings per share.   

What happened with Keurig Dr Pepper this quarter?

  • The company's revenue growth was propelled by a 3.6% improvement in volume and product mix, which was offset by slightly lower price realization of 0.2%, and 0.5% of negative foreign currency translation.

  • The combined organization operates in four segments: beverage concentrates, packaged beverages, Latin America beverages, and coffee systems.

  • In packaged beverages, Keurig Dr Pepper's largest business, year-over-year revenue increased 4.9% to $1.3 billion. The advance was due to higher owned and contracted manufacturing volume for the Canada Dry, BODYARMOR, Core, and Bai brands. Segment operating income dipped by 16% to $164 million, which the company attributed to input cost and logistics inflation not yet covered by pricing increases, as well as investments in new sales, delivery, and merchandising personnel.

  • The concentrates business expanded revenue by 3.1% to $331 million, primarily on the strength of price increases in the Dr Pepper and A&W labels, partially offset by the Sunkist brand. Operating income of $204 million was flat against the prior-year period.

  • The Latin America beverage business notched a modest 2.3% advance in revenue versus the third quarter of 2017, to $136 million. Higher pricing of nearly nine percentage points was offset by negative foreign currency translation of 5.8% and lower volume and mix of 0.6%. Operating income soared 145% due to a favorable comparison with the prior-year quarter, in which the division took a writedown of prepaid resin inventory.

  • In Keurig Dr Pepper's second-largest segment, coffee systems, revenue grew 0.4% year over year to $1.05 billion, as higher volume and mix of 2.5% was almost completely negated by lower price realization, including a strategic pricing investment in Keurig coffee pods. Operating income jumped 22% as productivity improvements and the timing of marketing spending offset inflationary pressures.

  • Total company adjusted operating income increased 14.3% to $697 million against the comparable quarter. 

  • During the last three months, the company entered into an agreement to purchase bottled water manufacturer Core Nutrition LLC for $525 million. Keurig Dr Pepper also acquired one of its customers during the period, regional soft drink brand Big Red. 

Keurig Dr Pepper logo on white background.

Image source: Keurig Dr Pepper  

Management's perspective

In the company's earnings press release, CEO Bob Gamgort praised Keurig Dr Pepper's healthy initial results and alluded to one of the organization's longer-term drags on earnings -- its heavy debt load: 

We're off to a great start as a combined company. Our new organization is working well and delivered a strong quarter, with both top- and bottom-line growth and market share strength across our major categories. We also repaid approximately $550 million of debt since the merger close. We remain confident in our outlook for 2018 and the long-term value creation framework we shared at the time of the announcement of the merger.

Keurig Dr Pepper has roughly $16 billion of borrowings on its books, which obligates the company for significant debt service: Interest expense in the third quarter of $178 million equaled nearly one-third of the operating income the company generated during the period. Management intends to bring the organization's debt-to-EBITDA ratio, which I calculate at roughly six times (i.e. debt is six times annual EBITDA), down to a more manageable leverage ratio of three times within a time frame of two to three years. 

Looking forward

In its third-quarter release, Keurig Dr Pepper maintained the initial full-year adjusted diluted earnings per share (EPS) target it shared with investors premerger of $1.02 to $1.07. In addition, management believes the organization will realize more than $600 million in merger synergies between 2019 and 2021, at a rate of roughly $200 million per year. Achieving these cost savings and reducing interest expense should provide significant near-term earnings leverage for the company if it can maintain its moderately improving top line going forward.

Asit Sharma has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.