Canada Dry Ginger Ale isn't a brand you think of as innovative. Its parent company, Keurig Dr Pepper (NYSE:DPS), however, has changed that with the surprise success of its Canada Dry-branded lemonade-ginger ale mix. The difficulty for the beverage specialist is that it runs up against two major players in Coca-Cola (NYSE:KO) and PepsiCo (NASDAQ:PEP). In addition, Keurig Dr Pepper faces challenging margins producing beverage concentrates, while coffee pods are much more profitable.
In this segment from Industry Focus: Consumer Goods, host Vincent Shen and Fool.com contributor Daniel Kline discuss some of the beverage company's recent successes.
A full transcript follows the video.
This video was recorded on Dec. 11, 2018.
Vincent Shen: Something that you mentioned, I think it's part of their Packaged Beverages business, this increase in the number of partnerships and some success they're seeing with some of the brands that are key parts of their portfolio, you could call it a more organic innovation with Canada Dry, for example, seeing some real success in terms of the volumes and the growth for that brand.
With the partnerships, how do you think this plays out longer-term, in terms of how Keurig will ultimately be able to gain on its bigger two competitors?
Dan Kline: Here's the thing. It is a challenging space. I mentioned to you before we started taping that almost the second the Peet's distribution deal was announced, I started seeing Peet's products in my grocery stores, in convenience stores in my area. So, the good news is, because you cannot as a grocery store chain say, "I'm not going to carry K-cups," or, "I'm only going to carry third-party K-cups." You simply have to have a pretty good selection, like a quarter of an aisle, devoted to just a wall of K-cups. That gives Keurig Dr. Pepper leverage into saying "Hey, we're already here. Can we have some shelf space for this?"
The challenge is that the companies they're going against, Coke and Pepsi, are absolute masters in the shelf space game. They will put money into it. They will put resources, people into making sure that they continue to have the best space. That's a financial challenge for Keurig Dr. Pepper, to make sure these Peet's beverages don't get the back shelf compared to whatever Coke is distributing, the Costa brand, and various other products.
Shen: Yeah, especially with the leader here, Coca-Cola, starting to really make its move into coffee with that big deal that you've mentioned.
Something else I wanted to talk about, in terms of these different reporting segments, how they break down for the business, is with their profitability and contribution to the bottom line. Interestingly, Coffee Systems and Beverage Concentrates actually lead the way when it comes to profitability. Concentrates have a 61% operating margin, Coffee Systems 32%. Packaged Beverages might bring in the most revenue. For this quarter, I think was about $1.3 billion out of the $2.9 billion. But the operating margin there, just 5%. That's something to keep in mind. I think this is just the nature, with the high margin behind producing and selling these concentrates, and the same thing on the coffee side, the high margins they can enjoy with these single-serve coffee products from Keurig and how that contributes to the profits.
Kline: Yeah, and selling concentrates isn't a sexy business. It's nothing we ever talked about with Coke or Pepsi. But it's very much like being a fully franchised restaurant model. There's very little risk involved. If the soda market declines by 10%, yes, they'll sell 10% less concentrate, but they're not going to have huge amounts of inventory tied up, they're not going to have the systemic problems that their bottlers might have if they lose 10% of their volume. It's very much a pure profit market and a sensible place. That's why you've seen Coke and Pepsi sell bottlers back, and no longer own control of some of that stuff.