I'm sure that it would take a long time to find a stock out there that has outperformed Celsius Holdings (CELH 2.12%) in the last five years. Its shares have skyrocketed almost 4,000% in that span. Surely, this company is doing something right. After all, it has rewarded investors even more than Tesla has in that same period of time.
This beverage business has made for a truly magnificent stock thanks to those eye-popping returns. Naturally, investors might be ready to hop on the energy drink maker's bandwagon in the hopes that the good times continue. Before doing that, though, there's a potential red flag to keep in mind.
A booming beverage business
I think it's a good idea to first understand what has made Celsius a fantastic stock. Anyone who is even remotely familiar with the company can quickly point to its outstanding growth. During the three-year period from 2019 to 2022, revenue increased at a compound annual rate of 106%. And through the first six months of 2023, sales were up 104% year over year. That momentum has not slowed down one bit.
Investors are correct to assume that the market for non-alcoholic ready-to-drink beverages is very mature. Just look at Coca-Cola. Its revenue in 2022 was less than what it was in 2012. However, Celsius has found remarkable success in what management calls "functional beverages," which is the fastest-growing segment of the drink market.
According to Grand View Research, energy drink sales in the U.S. are expected to rise at more than 8% annually between 2022 and 2030. Perhaps the key to this boom is just heightened interest from the public as it relates to health and wellness. Celsius stands out due to its products having no sugar, aspartame, artificial colors, or high fructose corn syrup.
Positioning the business well for continued success is a partnership with PepsiCo that the company announced in August 2022, which made the food and beverage giant Celsius' distribution partner both domestically and globally. "We have been extremely happy with our PepsiCo partnership and see a long runway of growth ahead across a variety of channels, including expanded retail, convenience, and foodservice," CEO John Fieldly mentioned on the second-quarter 2023 earnings call.
Even more encouraging for investors is that Celsius is generating positive net income, to the tune of $40.9 million in the latest quarter (Q2 2023 ended June 30). This was a huge improvement from the $9.2 million profit that was registered in the same period in 2022. Maybe this is an early sign of a consistently improving profitable enterprise.
Warren Buffett would pass on the stock
This all sounds good. But investors, particularly those who care about the long term, should always be wondering if a specific company has durability. This means that it's important to think through what could derail the business off its current trajectory over the next five or 10 years.
Warren Buffett tries to protect against this threat by finding companies that have an economic moat, or characteristics that can help them fend off rivals. This scenario allows for strong financial performance for extended periods of time.
In Celsius' case, I don't think there is the presence of an economic moat, at least not yet. In this industry, it seems like brand recognition is the key to lasting success, as people typically can build loyalty around a single company's product offering. While its growth is fantastic, Celsius commands 8.6% share of the U.S. energy drink market, which is good for third place. Consequently, I simply think it's still too small in the grand scheme of things to have a strong brand presence like what we see with Coca-Cola or Pepsi products.
A direct competitor like Monster Beverage has posted a much higher gross margin than Celsius in recent years. This tells me it has a stronger position in the industry.
This industry is extremely competitive, with no barriers to entry. It seems like anyone with the funding can go out and start a new energy drink business in no time. This leads me to have less optimism about Celsius' long-term durability. To be fair, Celsius looks to be on the right path to achieving greater scale and recognition, which could eventually lead to the development of an economic moat. I just don't think it's there yet. And this is a concern that all investors should be thinking about.
