SodaStream International, Ltd. Fails to Impress, but Opportunity Lies Ahead

SodaStream's first-quarter results beat Wall Street's expectations, but the beverage maker's performance was hardly refreshing.

Revenue growth at the Israeli-based business all but stalled, profit margins contracted, and the bottom line fell off a cliff compared to last year's stellar opening quarter. Sales of soda makers in the crucial U.S. market are primarily to blame, but the management team believes it can rejuvenate its second-largest market by doubling down on key retail relationships.

SodaStream Pure and flavor syrup. Source: SodaStream.

As summer approaches, investors' patience is wearing thin since shares are down 16% since the beginning of the year. Nevertheless, if operational issues get sorted out, SodaStream's upcoming product launch and retail tie-ups could provide a jolt of carbonation for shareholders.

The nuts and bubbles
In the past, demand for SodaStream soda makers spiked quarter after quarter due to the benefits of an easy-to-use and compelling product. But recent experience has shown that those products are not so easy to distribute for SodaStream and they're apparently growing less compelling in the eyes of the all-important American consumer. Overall, SodaStream faced significant hurdles in the first quarter due to tough comparisons and a multitude of misfires on the operational and marketing fronts, both of which led to uninspiring but on-target results:

Sales
First-quarter revenue increased 0.5% from $117.6 million in 2013 to $118.2 million in 2014. SodaStream faced headwinds in the Americas market in particular, where sales slumped by 28% year over year. This contrasted with sales increases of 17%, 28%, and 34% in the Western Europe, Asia-Pacific, and Central and Eastern Europe, Middle East, Africa regions, respectively.

Furthermore, the chart below reveals the unit sales trend by product category, revealing a drop-off in soda maker starter kit sales but healthy gains in consumables including carbonation refills and syrups.

Source: SodaStream 2014 first-quarter press release.

Expenses
The costs associated with selling and distributing soda machines seemed to balloon in almost every respective category during the first quarter. In some respects, these inflated costs were out of management's control. Foreign currency exchange rates, for example, were to blame for a slimmer gross margin percentage, which shrank from 54.5% in 2013 to 52.3% in 2014. The shift in product mix to higher-cost soda makers was also a culprit.

In other areas, including sales and marketing in particular, management was squarely at fault. CEO Daniel Birnbaum admitted in the conference call that the Super Bowl promotional spot actually consumed most of the first-quarter marketing budget and was "not as effective as we hoped for it to be." For perspective, sales and marketing expenses as a percentage of revenue increased from 33% in 2013 to 39% in 2014.

Profits
The combination of nearly stagnant revenue growth and inflated expenses led to a precipitous 82.8% decline in operating income during the first quarter, from $13.6 million in 2013 to $2.3 million in 2014. In percentage terms, that reflects a downtick in operating margins from 11.6% to 2%. Net income, consequentially, was a mere $1.8 million in the first quarter of 2014 compared to a more robust $12.1 million in 2013.

The silver lining for shareholders is that management's guidance earlier this year set an achievable bar for the company. Whereas Wall Street analysts estimated earnings of $0.01 per share in the first quarter, SodaStream delivered $0.08 per share on a diluted basis. This, however, compares with $0.57 per share reported in 2013.

Reformulating in 2014
SodaStream's management team was the first to admit that there wasn't much fizz in the first quarter. Flagging growth rates left a lot to be desired, but management remarked that they should recover, and it should happen sooner rather than later: "We expect to see a return to our historic growth levels in the second half of this year."

As a close follower of the company and a SodaStream shareholder myself, I have some doubts about how rapidly a turnaround can take root, but I believe a few key developments could catapult SodaStream in the right direction:

• Inventory issues need to be resolved. SodaStream blamed excess inventory that sat on retailers' shelves from the last quarter of 2014 for lower "sell-in" sales figures. While "sell-in" measures the product sold to retail outlets and not the ultimate consumer, it's understandable how the buildup from the holiday season affected first-quarter results. Nevertheless, this issue should sort itself out quickly and SodaStream's "sell-out" numbers according to management were only modestly better than "sell-in."
• The U.S. market needs a reboot, and SodaStream's new general manager of the Americas, Scott Guthrie, will have to provide a much-needed spark. Guthrie's career includes work at prominent consumer-facing brands like Disney, MTV, and Pepsi, so SodaStream's betting his understanding of American tastes will translate into greater sales of their beverage appliances. During the earnings conference call, Guthrie outlined four key levers he will pull to jump-start U.S. sales, including user appeal, branding, product lineup, and consumables sales including CO2 canisters.
• New product launches need to generate real excitement. SodaStream's management team raves about its products, which are admittedly high-quality from my experience. But its lineup of soda machines is so deep that it leaves the consumer perplexed about the various benefits of each. As my colleague Steve Symington points out, the new Play machine could change that by emerging as its signature product this summer. If that's the case, SodaStream needs to take the opportunity to whittle down the list of duplicate machines in the process.
• A prosperous relationship with Wal-Mart could seal SodaStream's fate. The new Americas general manager announced that SodaStream's teaming up with Wal-Mart starting this Saturday to occupy 20 feet of shelf space in 1,600 stores for 12 weeks. The size, scope, and length of this tie-up could be a catalyst for SodaStream, especially during a warm summer season when consumers are craving a cold beverage. I would venture to say that Wal-Mart's ability to move SodaStream products will speak volumes about whether Coca-Cola and Keurig Green Mountain have an outside shot at swaying consumers toward their do-it-yourself machine later this year.

Foolish wrap
Just as the stakes are rising in the at-home soda market, many onlookers would point to recent struggles at SodaStream as signs that the leader is folding under the pressure. But while it's true supply chain issues are constraining growth, customers appear to be impressed with the product. Quarter after quarter, sales of refills and flavors continue to edge higher, indicating at-home users find the increasing array of flavors and customization options appealing to their taste buds.

At this point, a buyer of SodaStream's stock acquires a well-run internationally focused business that's fumbling in the U.S. market, which coincidentally happens to generate $20 billion in revenue annually, according to IBISWorld research. What that means is that there's upside to be had if SodaStream cracks the code on U.S. consumers. At 20 times forward earnings, shares are trading at a price I'm willing to pay for that upside. Despite two iffy quarters, I think there's still some pop left in this soda stock.

SodaStream's new Play machine. Source: SodaStream.