There is no doubt that Red Bull took the market by storm. Its popularity skyrocketed as the company crafted a strong and trendy brand.
While Coca-Cola (NYSE:KO) tried to get in on the ground floor, their reputation for cornering the soft drink space did not prove helpful in this market. Countless competitors have sprung up to cash in on the growing energy drink trend, but only a select few like Monster (NASDAQ:MNST)have managed to carve out a substantial share of the market.
Is an energy drink stock what you need to fire up your portfolio? Find out more on this episode of Industry Focus.
A full transcript follows the video.
Sean O'Reilly: Get your caffeine fix, on this consumer goods edition of Industry Focus.
Greetings, Fools! I am Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. To my left is Vincent Shen. How are you today, sir?
Vincent Shen: I'm doing well, Sean. How are you?
O'Reilly: Not bad. We're going to talk some energy drinks here today. Did you bring me any? Like, a Red Bull, or anything?
Shen: Yeah, I'm really hopped up on caffeine right now, actually.
O'Reilly: That does sound about right. So, today we're talking about, more or less, what beverage companies are doing for growth these days because the traditional lines of Coke and Pepsi (NASDAQ:PEP), they are not high growth markets right now. In particular, the energy drink market is what they're going for. In addition to that, have you tried this Fair Life Milk that Coke's making?
Shen: That's kind of a different track for them, right? I really do not -- I can't even put them in the same room. I think Coca-Cola...
O'Reilly: When I saw that, one of our Foolish writers -- this was back in December now when it was first announced -- Asit Sharma wrote a great article about "Coca-Cola's Next Product Is...Milk" and then you read it and they teamed up with this huge farm in Wisconsin, I think, and they're mass producing this, supposedly, healthier milk.
It's got 50% more protein and calcium and all this stuff. But it's expensive. It's $6 or $7 for a gallon. That's mucho dinero. But as we'll see in a minute, this is how these beverage companies are going about it because their major advantage is, of course, their distribution. Not necessarily owning current, awesome brands in the energy drink industry.
Anyway, you've got them trying to do milk, juices, Vita coconut water, and of course the big enchilada of energy drinks. So, what's going on here?
Shen: Well, like you mentioned -- I want to stop right there really quick though. Have you tried Fair Life?
Shen: Okay. I haven't met anybody who's tried it yet.
O'Reilly: I'm not quite sure it's in Northern Virginia yet.
Shen: Oh, is that the -- oh. I didn't realize it was a regional rollout for them.
O'Reilly: Oh, yeah. For sure. Yeah.
Shen: Okay. So, as Sean mentioned earlier, Coca-Cola, Pepsi; they're seeing a lot -- they're basically seeing stagnant, if not decreases in their volumes year to year for their traditional carbonated beverages. Maybe 3% to 4% volume declines per year now. People in general, their health perception of normal Coke, or a Pepsi is just not good these days.
Too many calories, too sugary, and there's been a lot of media attention and general awareness of health brought to that.
O'Reilly: This is why Coke has Coconut water now.
Shen: So, one avenue of growth that they're trying leverage right now -- and it's kind of funny because these drinks aren't exactly healthy either.
O'Reilly: No, they're not.
Shen: But they're generally identified in the category of functional beverages where they provide -- they help you stay up, they help you energize, and compared to normal, carbonated sodas, these drinks have seen double digit CAGR in the past five years.
O'Reilly: The growth -- since I was in college -- the growth has been crazy.
Shen: Yes, I have to keep in mind, a good indicator of that is just the fact that there's been 100s of new energy drink products introduced in the past three years -- since 2012. So, everybody's trying to get a piece of this pie. The U.S. energy drink market is on track to hit about $21 billion, $22 billion by 2017. So, it's pretty substantial, though in the end, in the broad context of the U.S. beverage market it' sonly a single digit...
O'Reilly: A drop in the bucket, yeah.
Shen: It's not huge, but when you take in the growth though, it can still have a pretty substantial impact for a company like Coca-Cola. Their profits, their revenue growth; things along those lines.
O'Reilly: So, who are the major players? Because investors don't have a ton of options.
Shen: Unfortunately not. There's really only one pure play energy drink company that is publicly traded. The number one, actually, is Red Bull. Being an Austrian company they're privately owned.
O'Reilly: That founder – well, he started that in 1987. He's worth $5 billion now, or something.
Shen: Oh, wow.
Shen: Yeah, that started in 1987. It was first introduced into the U.S. market about 10 years later -- in '97 -- and that really kicked off the entire trend. I think at this point, like I said, private companies -- the numbers are a little difficult to track down sometimes, but I think most recently, for the past year, they did something like $6 billion, $6.5 billion in sales. So, pretty substantial.
O'Reilly: They're all -- correct me if I'm wrong -- every energy drink owes its life to Red Bull. They are the ones -- they're the Coke of the energy drink market.
Shen: I think, especially a few years ago before some of these other competitors really started gaining more market share -- when I thought of an energy drink, I actually just thought of it as a Red Bull. I'd say "Get me a Red Bull." Even generically, for any energy drink. So, they definitely started the trend. Something that we'll see among all these companies -- Red Bull was about a 43% market share, then Monster...
O'Reilly: That's amazing.
Shen: Yeah. So, these two -- Red Bull and Monster -- dominate most of the market. There's a lot of smaller players, but they're obviously the big dogs. Monster is around 39%, but recently, because of its deal with Coca-Cola, it's probably -- in the U.S. at least -- it's neck in neck. Red Bull's much more dominant worldwide.
O'Reilly: Got it. So, investors: you really can't -- unless you invested in Monster there's no real way to take advantage of this growth other than buy into Coke and Pepsi and all that stuff.
Shen: Yeah, exactly. I want to touch on that a little bit later. Options besides Monster. But if you want that pure play, it really is only the one option. It's definitely an interesting stock. Monster's trading about $131 a share right now. They're up 20% already, year to date. In the past year they pretty much doubled. Up 90%.
O'Reilly: What did they do with Coke about a year ago?
Shen: That actually resulted in a big jump in their stock price, too. I think it was in August they signed the deal, whereby Coca-Cola entered into this partnership. So, they acquired a stake in Monster. I think it was about 17% stake for about $2 billion. The exchange of expertise...
O'Reilly: And Monster got all of Coke's energy brands, which were arguably failing.
Shen: That was basically the exchange. So, Coca-Cola will be the preferred distributor and they're probably the best one in that regard [...]
O'Reilly: Well, given what you just said, that's three wins for Monster, in my opinion. They got $2 billion in cash, they got all of Coke's brands -- like a 'gimme', or something -- and they get access to Coca-Cola's distribution, which is arguably the most effective distribution system on God's green earth.
Shen: Well, it's not like Coca-Cola's coming out with nothing. Monster came about in 2002, I'm sure, as a response to Red Bull and how popular it was getting, and in the past decade they've built up a very, very competitive market share against Red Bull in the states. I think what some of these smaller players have that the bigger companies like Coke and Pepsi haven't been able to master is the marketing and the image brand that they've created.
O'Reilly: What is it that Red Bull -- they had a guy jump from space, basically?
Shen: Oh, yeah. I had forgotten about that. But they do a lot of these extreme sports events. If you go on their website you can see all these different -- skateboarding, concerts, music events. When I went to a music festival in New York on Randall's Island called The Governor's Ball there are tons of representatives from Red Bull. They were doing a really good job in terms of marketing, especially to younger consumers who are setting the trend of making their products look cool, and popular.
Shen: Going back to that deal, I think that's a big part of what Coca-Cola gets because they're handling the distribution for Monster, but they're also handing over their entire energy drink portfolio, which included a bunch of brands. NOS, Full Throttle, Burn, Mother, Relentless -- I haven't even heard of some of these.
O'Reilly: I forgot about Full Throttle.
Shen: They're like "All right. Monster, you guys have the image thing, you have the brand things down, the marketing. So, we're going to let you handle that." And that's essentially the exchange that they're going through.
O'Reilly: So, we're obviously Motley Fool, we like investing. What do you think of Monster as a business? Returns on equity, capital; all that stuff?
Shen: The growth is really, really impressive. They've grown their revenue at about 16%, 17% CGAR over the past five years. This is compared to an overall beverage industry that's pretty much been flat, or stagnant.
O'Reilly: Right. People like their B-12 vitamins.
Shen: Apparently so. It's always in those drinks; the B-12.
O'Reilly: You look at the back of these energy drinks, it's like "Daily portion of B-12: 400%".
Shen: I'm glad you bring up the ingredients because Monster kind of bucked the trend, too. When they first introduced their drink they did the big 16oz cans.
Shen: Red Bull at the time was still a small, 8oz can. So, just to give you some perspective, one 16oz Monster drink has about 160mg of caffeine. For context, a single shot of espresso at Starbucks has about 75mg of caffeine. So, you're getting about two shots of espresso in each of these cans.
O'Reilly: If you're staying up all night playing Xbox you need it.
Shen: You drink two or three of them, before you know it, you're going to be completely wired.
O'Reilly: Good to go.
Shen: So, their revenue has grown at a very impressive pace. Their earnings are right on track, too. They have about 20% -- their free cash flow is strong. The thing is, their margins are really good. Coca-Cola is 27% margins for the EBITDA, and Monster bests that, even. They're over 30%.
O'Reilly: Coke's known for its pricing power. This is why it's one of Buffett's favorite companies. That's saying something right there.
Shen: I think broadly, this category for energy drinks, in general, these functional beverages have been able to just command high prices. When I go to the market I see Red Bulls and they're kind of pricier than the...
O'Reilly: They're $3 or $4, yeah.
Shen: So, that has contributed to the success they've had and their stock price, admittedly does reflect some pretty high expectations of investors. Like I said, they're trading about $131 a share. That's equivalent to 40x their expected 2015 earnings. So, definitely not a cheap stock. You're paying for that growth, but considering the portfolio they just took over, their agreement with Coca-Cola for distribution, the continued strength of the brand; they'll probably be neck in neck with Red Bull, if not surpass them for the U.S. market.
Who knows where that can go in terms of the international growth considering what Coca-Cola can offer?
O'Reilly: I wonder if there's ever going to come a day when Pepsi offers to buy Red Bull or something. I'm wondering what the end game is because it's a private company, but eventually somebody's going to want to cash out.
Shen: It certainly wouldn't be a small deal. Coca-Cola looked into doing a Monster acquisition.
O'Reilly: That's right! Yeah.
Shen: A couple years ago. I think that was 2012.
O'Reilly: And they didn't, and now it's up three fold.
Shen: They walked away, yeah. It's up several times that price now. Their market cap is currently about $22 billion. So, not a small acquisition by any means if somebody wanted to pursue that. I think Red Bull's probably even bigger than that. So, definitely something to consider.
O'Reilly: So, if I come up to you and say "Vince, I really want to get in on this energy drink trend, but Monster's kind of pricey. I'm a value guy." What are my options then? Am I just 'stuck'? Do I have to assume that Coke and Pepsi are going to find a way to get a piece of this?
Shen: Debatable. I think in terms -- Coca-Cola for example, entering this partnership is a smart move because they're not going to -- though one of their drinks, NOS, developed a pretty sizable piece of the market -- I think NOS has 3% of the market. They had $300 million in sales last year compared to Red Bull in the U.S. had 10x that.
But still, they were able to build that up somewhat, but in the end, them handing that over and allowing Monster to use some of their expertise in that regard is a good play. I think, in an alternative investment option it's through Coca-Cola because some of that growth is going to hit their bottom line directly.
O'Reilly: Very good. Well, thank you for your thoughts, Vince.
Shen: Thank you, Sean.
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For Vincent Shen, I am Sean O'Reilly. Thanks for listening, and Fool on!
Sean O'Reilly has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool recommends Apple, Coca-Cola, Monster Beverage, PepsiCo, and Starbucks. The Motley Fool owns shares of Apple, Monster Beverage, PepsiCo, and Starbucks and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. 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.