KDP - Keurig Dr Pepper: Buy The Post-Earnings Dip

2023-05-01 06:07:27 ET

Summary

• Keurig Dr Pepper has dropped over 8% after reporting its earnings.
• The latest earnings showed a large decline in the bottom line but this is solely due to a non-operational impact.
• Despite having similar sales growth, its current valuation remains meaningfully discounted compared to peers.
• I rate the company as a buy.

Investment Thesis

Keurig Dr Pepper ( KDP ) has slumped nearly 9% in the past few days, which is pretty unusual for the low-beta consumer staples company. The market seems to be concerned about the latest earnings, which showed a massive decline in the bottom line. However, I believe this is an unjustified overreaction and the pullback presents a great buying opportunity for investors.

The latest earnings were not bad as top-line growth remains solid and the bottom line dropped only because of non-operational impact, which would normalize in the coming quarters. The company's substantial amount of authorized buyback should also provide meaningful support for the share price. After the drop, its current valuation looks pretty discounted compared to peers and should offer a great margin of safety. Therefore I rate the company as a buy.

Latest Earnings Are Solid

Keurig Dr Pepper announced its first-quarter earnings last week and the results are actually pretty solid. The company reported net sales of $3.35 billion, up 8.9% YoY (year over year) compared to $3.08 billion. The growth was driven by a price increase of 9.9%, partially offset by a 1% decline in volume, which demonstrates strong brand loyalty and pricing power. While price increases of this magnitude are unsustainable in the long run, it should help the company get through the weakening economy in the near term.

US Refreshment Beverage, which accounts for 60% of total revenue, grew 12.7% from $178 billion to $2.01 billion. The growth is mainly driven by the strong momentum in Dr. Pepper, Crush, and Mott's. International was the strongest segment, with revenue up 17.2% from $354 million to $415 million, accounting for 12.4% of total revenue. Besides a price increase of 9%, the volume also increased by 7.7%, as the company continues to gain market share in countries such as Mexico and Canada. US Coffee was the only segment that recorded a decline, with revenue down 1.3% from $943 million to $931 million, accounting for 27.8% of revenue. The segment was weak as demand for coffee capsules remain under-pressured.

The bottom line was mixed. Due to inflationary pressure on transportation and labor expenses, SG&A (selling, general, and administrative) expenses as a percentage of sales increased 160 basis points from 33.1% to 34.7%. This resulted in the net income down 20.2% YoY from $585 million to $467 million, or 13.9% of total revenue. However, the drop is largely due to the gain on litigation settlement in the prior year, which created an unfavorable YoY comp. On an adjusted basis, the net income was actually up 1%. The adjusted diluted EPS was $0.34 compared to $0.33, up 3% YoY. The company also reaffirmed its guidance for FY23, which is encouraging. It continues to expect net sales growth of 5% and adjusted diluted EPS growth of 6% to 7%.

Buybacks and Dividends

Thanks to the strong balance sheet and consistent sales growth, Keurig Dr Pepper has been returning cash back to shareholders through both buybacks and dividends. I believe buybacks will be a huge catalyst for the share price in the near term. At the moment, the company has approximately $3.4 billion remaining under its share repurchase authorization expiring in 2025. This is significant as it could potentially retire up to 7.4% of outstanding shares. Considering the recent pullback, I believe the management team may speed up the buyback, which could provide meaningful support for the share price.

Dividend investors should also keep track of Keurig Dr Pepper. While the current dividend yield is pretty mediocre at just 2.41%, the company has been actively growing the dividend in the past two years, with the quarterly payout increasing 33.3% from $0.15 to $20. Considering the low payout ratio of 46.6% compared to PepsiCo's ( PEP ) 65.7% and Coca-Cola's ( KO ) 70.6%, I believe we may see more upsized dividend increases in the future.

Discounted Valuation

After the recent pullback, Keurig Dr Pepper's current valuation looks pretty compelling in my opinion. The company is trading at an fwd PE ratio of 18.3x, which is discounted compared to both peers and its own historical average. As shown in the first chart below, the current multiple is meaningfully below major beverage companies such as PepsiCo and Coca-Cola. The two company has an average fwd PE ratio of 25.4x, which represent a premium of nearly 28%. I do not think the large valuation gap is justified as the company's latest revenue growth of 8.9% is pretty much in line with peers, as shown in the second chart below. On a historical basis, the current multiple is also trading at a discount of 16.1% compared to its 5-year average fwd PE ratio of 21.8x.

Investors Takeaway

Overall, I believe the recent pullback is unjustified and present a great buying opportunity for Keurig Dr Pepper. The huge reaction to the declining bottom line seems vastly exaggerated as the drop is simply caused by unfavorable comparability, rather than any operational missteps. The top line was also very solid as the international and refreshment beverage segments continue to see strong momentum with double digits sales growth. Despite reporting upbeat growth, the company's valuation remains well below peers and its historical average. I believe the discounted valuation should present decent upside potential while the huge buybacks should provide solid downside protection. Therefore I rate the company as a buy.

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