SodaStream ( SODA ) is down by more than 38% over the last six months as the company delivered disappointing earnings for the last quarter of 2013 and the partnership between Coca-Cola ( KO 0.55% ) and Keurig Green Mountain ( GMCR.DL ) to enter the home soda market is generating serious concerns among investors.
But the company is still the first mover in a business with enormous potential for growth, revenues continue to expand at a healthy rate, and SodaStream is building valuable partnerships with different companies to consolidate its competitive strengths.
Coca-Cola and Keurig Green Mountain have recently announced a $1.25 billion agreement by which the soda giant is buying a 10% stake in Keurig Green Mountain. The companies are also entering an agreement to collaborate in the development and introduction of Coca-Cola's products for use in Green Mountain's forthcoming Keurig Cold machine, which is expected to enter the markets during Green Mountain's fiscal 2015, beginning in October of this year.
Coca-Cola is the undisputed global leader in soft drinks as the company benefits from extraordinary brand power and unparalleled resources to invest in areas such as marketing and product development. The fact that the company has chosen to partner with Keurig Green Mountain, which has successfully popularized the home coffee category over the last several years, represents a considerable competitive threat for SodaStream.
But it's far too early to know how the competitive dynamics may play out. Coca-Cola entering the business could generate increased attention and popularity for the home soda category, and Coca-Cola is unlikely to compete in the low end of the pricing spectrum, so SodaStream could be favorably positioned to compete in prices.
The deal between Coca-Cola and Keurig Green Mountain is certainly a risk factor to monitor in the medium term, but it could actually turn out to be a positive for SodaStream if the home soda category gains validation and the company manages to compete effectively in prices.
Another reason for the negativity surrounding SodaStream is the recent decline in profit margins. During the fourth quarter of 2013, the company reported a solid increase of 26.4% in revenues, but EBITDA declined by a worrisome 45.2% due to margin erosion.
Machines usually account for a big percentage of sales during the holiday quarter, and this has negative implications on margins as SodaStream makes most of its money from the more profitable carbonators and flavors as opposed to machines. The last holiday season has been remarkably competitive when it comes to prices, and SodaStream is prioritizing sales growth over profit margins, so the company offered aggressive discounts during the period.
New distribution channels like the Home Shopping Network generated additional pricing pressure during the quarter, and the company incurred higher-than-expected costs in areas such as product reconfiguration expenses due to the conversion of starter kits to megapacks and the redeployment of inventory from the U.S. to Canada, among other factors.
Management admits that execution was at subpar levels during the quarter, and SodaStream needs to step up its game if it's going to improve efficiency and recover profitability in the future.
It will be important to watch SodaStream's pricing power and management's ability to streamline operations. But as long as the company can sustain healthy sales growth over time, a recovery in margins sounds like a plausible scenario.
The glass half-full
SodaStream continues generating healthy sales growth, especially when it comes to the much important renewables segment. Starter kits unit sales increased by 39% during the last quarter, units of carbonator refills grew 25%, and flavors units were up 32%. Healthy carbonators and flavor sales bode well in terms of future profitability, and they are also showing that customers are actively putting the machines to good use.
The company has partnerships with companies such as Samsung and Whirlpool to expand its presence in refrigerators and other home appliances. SodaStream's products are available at more than 60,000 retail stores in 45 countries, and flavors include offerings from players like Kraft Foods, Campbell Soup, and, more recently, Sunny Delight, among many others.
The worldwide carbonated beverage industry is worth around $260 billion according to management, and SodaStream has the first-mover advantage in the home carbonation category. As long as the company continues expanding both its client base and partnerships with other companies to consolidate its competitive position, SodaStream offers enormous potential for expansion from current levels.
Falling profit margins during the holiday quarter and growing competitive pressure are considerable risks to watch. But SodaStream continues increasing its sales at a remarkable rate, while gaining popularity and competitive strength in an industry with enormous potential for growth.
The risk in SodaStream is certainly higher than average, but when it comes to a small position in a diversified portfolio, upside potential seems to me more than enough to compensate for that risk.