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Will Craft Soda Erupt Like Craft Beer?

By Ted Cooper – Sep 11, 2013 at 3:57PM

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Craft soda is emerging with the backing of Millennials.

As craft beer takes the nation by storm -- making kings out of once-small brewers like Boston Beer (SAM 0.89%) -- the same trends that are driving sales of the alcoholic beverage may soon drive sales of its non-alcoholic counterpart: craft soda.

The craft soda industry has emerged on the same formula that brought craft beer to the forefront of American interests. Namely, the product's high-quality, natural ingredients give it a richer, more flavorful finish than the mass-produced, high fructose corn syrup-laden sodas made by Coca-Cola (KO 0.10%) and PepsiCo (PEP -0.52%). Besides being a better-tasting drink, craft soda is also much healthier. Instead of using high fructose corn syrup, craft sodas use cane sugar -- a natural ingredient.

Although many craft sodas are concocted on-site by local restaurants, there are a few craft soda producers that distribute their products nationwide, including Reed's. Reed's has several product lines, including Reed's Ginger Brews, Virgil's Cream Soda, and Sonoma Sparkler Sparking Juices. The company is small -- sales totaled just $30 million in 2010 -- but is growing quickly; sales were just $6.78 million in 2003, so they have grown at an 18% compound annual rate even through a deep recession. Sales have doubled since 2009.

Such impressive growth is a testament to the category's growing popularity among mainstream consumers. So popular, in fact, that premium coffee giant Starbucks (NASDAQ: SBUX) is developing its own line of sodas to be made by baristas upon request.

Craft beer points the way
Craft sodas are popular with the Whole Foods (NASDAQ: WFM) crowd that wants natural options with real ingredients that are also better-tasting and more exclusive than mass-produced beverages. This is the same crowd that drives demand in the craft beer market, which may be an indication of where the craft soda market is headed.

Boston Beer began in 1984 when its founder, Jim Koch, brewed the first batch of Samuel Adams in his kitchen. The hand-brewed beer that uses all-natural ingredients was immediately successful, catching the craft beer wave at its beginning, and has since grown into America's largest craft brewer.

Even after its tremendous success over nearly three decades, Boston Beer has a long runway for growth. Consumers are willing to pay a higher price for craft beer than for its mass-produced counterpart, which makes the category a significant threat to America's largest brewers. As a result of consumers' growing preference for full-flavored beer, Boston Beer's revenue has more than tripled revenue since 2003 and will likely experience high single-digit annual revenue growth over the next decade.

Look out, Coca-Cola
The parallels between craft beer and craft soda are numerous. Like big beer, big soda mass-produces its products using cheap, low-quality ingredients that enable companies to maximize production quantities and sell the products at a high margin. Like craft brewers, craft soda makers improve upon the mass-produced product by mixing in high-quality ingredients in a carefully controlled process, thereby producing a better-tasting alternative.

Reed's is just one among many small players in the craft soda market, with much of the market composed of local producers that do not have nationwide distribution agreements. However, the fragmented nature of the craft soda market is not enough to keep it from posing a real threat to the soda giants.

Sensing a growing threat, PepsiCo introduced Sierra Mist Natural, among other natural alternatives to its soda line-up. However, while the products lack the much-maligned high fructose corn syrup, the "natural" sugar actually comes from genetically modified sugar beets -- a deal-breaker for many potential customers.

PepsiCo recently settled a lawsuit regarding its use of the phrase "all natural" to describe Naked Juice, the company's line of fruit juices. It turns out that the fiber and many of the vitamins included in the drinks are actually synthetic versions of the real thing. Naked Juice is the primary competitor of Coca-Cola's Odwalla line of beverages, which is marketed as having "fresh-sourced" fruits and vegetables in its drinks. But while some of Odwalla's juices are pure fruit juice, others contain synthetic ingredients.

Despite their shortcomings, Coca-Cola and PepsiCo have good reason to be interested in the growing market for healthy alternatives to mass-produced soda. Consumers increasingly view synthetic ingredients as unhealthy. This perception caused an 11% decline in the use of high fructose corn syrup from 2003 to 2008.  The fast growth of companies like Reed's, Whole Foods, and The Fresh Market (TFM) are further indications of the American public's shift toward healthy alternatives -- even if they have to pay a premium.

Bottom line
The synthetic products and ingredients that emerged when the baby boomer generation reached adulthood are now giving way to the natural products demanded by Millennials. Therefore, big soda companies need to reposition themselves for Millennials to avoid getting caught flat-footed like big beer.

Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Boston Beer, Coca-Cola, PepsiCo, Starbucks, The Fresh Market, and Whole Foods Market. The Motley Fool owns shares of Boston Beer, PepsiCo, Starbucks, and Whole Foods Market. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Coca-Cola Stock Quote
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Boston Beer
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