NSRGY - Keurig Dr Pepper: Stable Prospects

2023-06-08 04:45:58 ET

Summary

• Q1 2023: strong performance from U.S. refreshment beverages and international segments offset by continued softness from coffee.
• Near term, momentum could continue while coffee weakness could improve as mobility differences between quarters narrow. Moderating inflation is a positive for margins.
• A number of positive factors could support medium-term performance including C4 energy drink contribution, U.S. soda market share gains, and iced coffee expansion among others.

A number of positive factors could support near term and medium term financial performance for American beverage giant Keurig Dr Pepper ( KDP ). Trading at a discount relative to rivals, the stock may be worth a look to some.

Q1 2023: net sales up, operating income down, margins down, strong U.S. refreshment beverages, and international segments offset by soft U.S. coffee segment

For the quarter ended March 2023, Keurig Dr Pepper's net sales rose 8.9% YoY to USD 3.35 billion on the back of price (9.9% contribution), offset by lower volume/mix of -1%. By segment:

• U.S. refreshment beverages reported strong performance with net sales up 12.7% YoY to USD 2 billion driven by favorable net price realization of 12.5%, and a 0.2% contribution from volume/mix. Performance was helped by the recent launch of Dr Pepper Strawberries & Cream, as well the contribution from their recently announced sales and distribution partnership for C4 Energy.

• U.S. Coffee net sales decreased 1.3% YoY to USD 931 million driven by higher price contribution of 5.3% which was more than offset by a 6.6% decline in volume/mix. The segment's weakness was largely due to normalizing at-home coffee-consumption due to loosening mobility restrictions post-pandemic.

• International segment reported sales up 17.2% YoY to USD 415 million, driven by higher net price realization of 9% and volume/mix growth of 7.7%.

GAAP operating income for the quarter was down 39.5% YoY to USD 584 million, driven by the impact to GAAP gross profit growth due to costs outpacing sales growth as a result of inflation, and the unfavorable impact of items affecting comparability including the gain on the Body Armor litigation settlement in 2022, and a change in accounting for non-cash stock compensation expense, among others. Excluding items affecting comparability, adjusted operating income decreased 4.5% YoY to USD 699 million, partly due to inflation and increased marketing spend. By segment,

• US refreshment beverages GAAP operating income dropped 30.4% YoY to USD 490 million, largely due to items affecting comparability as well as headwinds from inflation among other reasons. Excluding items affecting comparability, adjusted operating income for the segment increased 11.6% YoY to USD 508 million.
• U.S. coffee GAAP operating income decreased 9% YoY to USD 232 million driven by unfavorable volume/mix, inflationary pressures and the unfavorable impact of item affecting comparability, partially offset by higher net price realization and productivity. Excluding items affecting comparability, adjusted operating income for the segment decreased 5.3% YoY to USD 285 million.
• International segment GAAP operating income rose 25% YoY to USD 80 million, driven by strong sales growth and productivity, as well as items affecting comparability partially offset by inflationary pressures. Excluding items affecting comparability, adjusted operating income for the segment increased 18.3% to USD 84 million.

Near term, KDP continues to expect net sales growth of 5% on a constant currency basis and adjusted diluted EPS growth of 6%-7% for 2023. Dr Pepper Strawberries & Cream was launched only in February 2023 and sales could continue gaining momentum, contributing to near term top-line growth.

KDP's U.S. coffee segment may continue to see some softness as demand for at-home coffee consumption normalizes, but the company expects trends to improve towards the latter half of the year as mobility differences relative to last year begin to narrow.

Meanwhile, inflation continues to moderate, a positive trend for KDP; not only could this stem any market share erosion to store brand sodas which have been enjoying brisk sales at the expense of national brands, but could also ease margin pressures. KDP's gross margins have trend downwards over the past few quarters, partly as a result of inflationary pressures.

Looking further ahead…

Contribution from C4 Energy distribution expected in 2024

Last December, KDP acquired a 30% equity stake in Nutrabolt. The investment allows KDP to sell Nutrabolt's products (which includes energy drink brand C4 Energy, and recovery drink brand Xtend) in "the vast majority of KDP's company-owned direct store distribution territories", thereby expanding KDP's reach in the fast-growing energy drinks market (growth forecast in the high single digits over the coming years compared with low single digits for sodas).

The transition of C4 Energy distribution to KDP is underway this year. With 2023 considered to be a transition and investment year, the strategic partnership will have limited impact to KDP's financial performance this year but is expected to be accretive in 2024 .

Dim industry prospects for carbonated soft drinks but market share gains can support medium-term top line growth

The U.S. soda market is expected to grow in the low single digits . Gen Zs, the next generation of consumers, are notoriously health conscious and shy away from sugary sodas with artificial flavors and colors, suggesting dim growth prospects for the industry barring any significant change in their beverage preferences. KDP's flagship brand Dr Pepper for instance is most popular among millennials and Gen X, while Gen Z makes up a tiny fraction ( 6% ) of consumers.

Market share gains have helped support KDP's financial performance over the years, and continued innovation and marketing investments could potentially help maintain this momentum medium term. Dr Pepper has grown its market share in dollar terms by 9% between 2003 and 2021 compared with a 21% drop in the overall carbonated soft drinks category overall.

By volume, Coca-Cola (KO) currently leads with roughly about 40% market share, followed by PepsiCo (PEP) with about 29% and Keurig Dr Pepper with 25%.

Pushing into iced coffee segment to tap into growing popularity

KDP launched a new line of coffee machines with more options for ice coffee along with new K-Cup pod varieties specially crafted for ice coffee, in response to growing millennial and Gen-Z demand for ice coffee, which is driving the cold brew market - the cold brew coffee segment is poised to grow from just under $500 million last year to $3.11 billion by 2030 , according to data from Skyquest.

Broad beverage portfolio, and strategic efforts

The overall beverage market in the U.S. is expected to continue growing and KDP with a wide portfolio of leading brands across both carbonated and non-carbonated beverage segments including water (enhanced and flavored), RTD tea and coffee, juice, juice drinks, mixers and specialty coffee, is positioned to benefit (KDP offers more than 125 owned, licensed, and partner brands).

KDP's continued investments in strategic initiatives including partnerships, acquisitions, marketing investments, and innovation could deliver dividends medium term. Recent initiatives include a partnership with Blue Bell to launch a new Dr Pepper float ice cream, a new distribution agreement to distribute Red Bull products in Mexico, as well as marketing and brand building efforts such as launching a new AI-powered tool for Snapple's "Snapple Real Facts" program to increase customer engagement, a marketing collaboration between KDP's Canada Dry Ginger Ale and Anwar Carrots , and Keurig Dr Pepper and Rolling Stones . KDP has also been acquisitive, taking stakes in energy drink company Nutrabolt, and non-alcoholic beer company Athletic Brewing .

Risks

The beverage industry is highly competitive and competition is intensifying in high-growth segments that KDP is expanding into, such as energy drinks and iced coffee. In RTD iced coffee, already competitive with beverage giants like Monster Beverage, Starbucks ( SBUX ), Coca-Cola's Costa, and Danone's ST?K (DANOY), new players continue to enter; in April, Nestle ( OTCPK:NSRGY ) launched Ice Roast (their first ever soluble iced coffee product), and Victor Allen launched their Snickers ice coffee . In February, Dunkin' Donuts rolled out their canned iced coffee drinks.

Competition is heating up in the energy drinks space as well, a market dominated by energy drink heavyweights Monster Beverages, Red Bull, and Rockstar Energy; beverage brand Prime launched a new energy drink in January this year, and rapper Flo Rida, a major marketing force behind energy drink brand Celsius during its early days, is planning to launch his own energy drink brand JettSet .

Conclusion

Analysts are mostly neutral on the stock.

At a forward P/E of 17.44, KDP is trading at a discount relative to rivals Coca-Cola ( 23.11 ), PepsiCo ( 24.8 ), and Monster ( 37.9 ), as well as a discount to its historical average.

This is possibly a reflection of near term softness from KDP's coffee business (which rivals are not affected as much by). Medium term prospects however are stable. Receding inflation and management's expectations of improving coffee performance towards the latter half of the year as mobility differences between quarters narrow could have a positive impact on KDP's stock. Some may view it as a buy, while others may view it as a hold.

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