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1 Chart Reveals SodaStream’s Margin Woes

By Isaac Pino, CPA - Mar 10, 2014 at 6:30PM

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All eyes were on one line-item when SodaStream announced results.

SodaStream, in recent years, has taken off in America, attempting to disrupt the veritable Coca-Cola and Pepsi duopoly with its at-home soda machines and its razor-and-blade business model. Unfortunately, that model only delivered razor-thin profit margins for SodaStream during the latest quarter.

SodaStream's margin woes, in fact, were the major storyline after it announced fourth-quarter results, surpassing the Green Mountain Coffee Roasters and Coke chatter as well as the soda maker's modest 16% increase in U.S. sales.

What happened? In a nutshell, there was a breakdown during the holiday season as the company scrambled to address slumping Black Friday retail sales. Their efforts, in turn, snowballed into cost overruns and an unfavorable product mix, all of which led to a sharp fall off in margins at the end of 2013:

As you can see, SodaStream had been humming along quite nicely for most of the year, raking in an average gross margin of 54.3% and average net income margin of 10.4%. Both of those fell by double digits in the fourth-quarter, to 42.4% and 0.4% respectively.

SodaStream's management team laid out the reasons for the margin compression during the company's conference call. The key takeaways, in order of significance, are listed below:

1) Price cuts on soda makers. A 10% price reduction on machines accounted for nearly half of the gross margin miss and was due to an emphasis on household penetration over profitability. This strategic move seemed to result from lackluster Black Friday sales, which could be a temporary blip on the radar.

2) Higher product costs. There were two culprits that led to higher product costs, including cost overruns on SodaCaps and a reconfiguration of finished goods during the quarter. This led to 30% of the margin shortfall and also appears to be an addressable inefficiency issue going forward.

3) Lower gas sales. As retailers faced slumping sales, they pulled back on certain inventory, including SodaStream's spare carbonators and gas refills. Since these are SodaStream's highest-margin products, this had an outsized effect on margins. It's not clear yet whether this issue could persist if retail foot-traffic remains stagnant.

4) An unfavorable currency exchange. During the fourth-quarter, the Israeli shekel strengthened versus the U.S. dollar. The movement was beyond what the company forecasted and had a negative impact on earnings that could persist in the quarter ahead.

As these negative events unfolded, the company indicated they took immediate actions to curtail the losses. Nevertheless, SodaStream barely managed to squeak out a profit of 3 cents per share compared to analysts' projections of a penny.

Going forward, additional measures will obviously be necessary. For one, management claims they will be much more selective on promotional deals where margin might be sacrificed. Likewise, they are retooling their supply chain to make it easier to respond to shifting demand across countries, a key problem in the 'reconfiguration' issue. Along with these changes, the manufacturing and shipping process could become more flexible as the company plans to ship separate components for assembly instead of a final product to various regions in the future.

SodaStream's Source machine. Source: SodaStream

Foolish takeaway
SodaStream has a lot to prove during the upcoming year, whether it's related to operations or demand creation for the razors (the machines) and blades (the syrups and gas refills) of this business. For the fourth-quarter, sales were robust as soda maker units grew 39%, gas refills grew 25%, and flavors rose 32%. It's clear the company's products are still resonating around the world. Walking that fine line between boosting product sales and managing costs will be critical as SodaStream tries to strengthen its foothold in an increasingly competitive at-home soda market.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

SodaStream International Ltd. Stock Quote
SodaStream International Ltd.
SODA
The Coca-Cola Company Stock Quote
The Coca-Cola Company
KO
$52.99 (1.04%) $0.55
Keurig Green Mountain, Inc. Stock Quote
Keurig Green Mountain, Inc.
GMCR.DL
Pepsico, Inc. Stock Quote
Pepsico, Inc.
PEP
$162.24 (1.54%) $2.46

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