COCO - Vita Coco: Good Prospects For Coconut Water Market Leader

2023-05-26 08:36:33 ET

Summary

• Double-digit sales growth and strong margin recovery in Q1 2023.
• Positioned to benefit from positive industry prospects and opportunities to expand addressable market. Little meaningful competition.
• Still largely a single product company which leaves Vita Coco vulnerable to changing consumer tastes.

Coconut water market leader Vita Coco ( COCO ) is positioned to benefit from several fundamental growth drivers including a growing interest in coconut water beverages worldwide, as well as strategic efforts to expand their addressable market. There is little meaningful competition and scale and first-mover advantages could keep Vita Coco a market leader for the foreseeable future but as a single product company, changing consumer preferences is a risk.

Q1 2023: Double-digit sales growth, margins recover

Vita Coco had a solid quarter in Q1 2023 (quarter ended March 2023). Sales were up 14% YoY to USD 110 million driven by Vita Coco Coconut Water (Vita Coco's biggest product segment by sales) which saw sales rise 17%. All categories saw sales increase during the quarter except Other (which includes clean energy drink Runa, water brand Ever & Ever, protein water brand PWR LIFT, and Vita Coco product extensions) whose sales were marginally down.

Of note, consolidated gross margins increased approximately 11 percentage points to 30.7% for the quarter compared with 19.8% the same quarter last year. The gross margin expansion was primarily driven by improving transportation costs as well as pricing actions in 2022. Net income tripled to USD 6.7 billion.

Management increased their guidance with sales expected to rise 9%-12% in FY 2023 (from 9%-11% previously) and gross margins expected at 32%-34%, a considerable improvement from FY 2022 when gross margins were around 24% .

Positive industry prospects

After declining a few years ago, coconut water sales in the U.S. returned to growth in 2020 and long term prospects appear to be positive with various research reports expecting the market to grow by double digits over the coming years. Worldwide prospects are positive as well with growth forecasts in the high single digits and above over the coming years fueled by ongoing wellness trends. Vita Coco, as the undisputed market leader with a 50% market share in the U.S. ( higher including private label), 82% market share in the U.K. and a presence in 30 countries worldwide should be a beneficiary.

Beverage giants Coca Cola ( KO ) and PepsiCo's ( PEP ) (Coca Cola sold coconut water brand ZICO in 2021 while PepsiCo discontinued its ONE coconut water brand) scale back from the coconut water space suggests Vita Coco currently faces relatively little meaningful competition. Scale advantages from Vita Coco's market leading position along with first-mover advantages could potentially keep smaller competitors and new entrants at bay and help the company maintain its market leading position in the foreseeable future. Management has highlighted opportunities for further household penetration for the coconut water category which at 23% is significantly lower than cranberry juice (52%), and orange juice (72%).

Additionally, Vita Coco's advertising intensity is quite low at 3.4% in FY 2022 compared with 10% for Coca Cola. With an eye on the long term, Vita Coco may have some room for further increases in ad spend which could potentially drive top line growth and market share gains although it may come at the expense of short term profitability (Vita Coco's net margin of 2.8% is far behind Coca Cola's 22.7% ).

Exploring opportunities to expand addressable market

Vita Coco is exploring opportunities to increase coconut water consumption occasions and expand its addressable market. Notable efforts include new flavor launches (including mango flavored coconut water), the launch of a new barista milk product (a blend of coconut water and coconut cream) in partnership with LA-based Alfred Coffee chain, the launch of a canned cocktail line in partnership with Diageo capitalizing on the fast-growing RTD canned cocktails market), and a partnership with DoorDash to market its coconut water as a mixer and hangover cure .

Plant milks are seeing robust growth along with increased vegan diet adoption particularly among Gen Zs, and coffee shops are fast emerging as the next frontier of growth. Meanwhile RTD cocktails are driving overall demand for RTD beverages, a trend expected to continue over the coming years.

No debt, free cash flow positive

Vita Coco is in good shape financially with no debt (debt to equity stands at 0.03 ), a current ratio of 3.32 and a quick ratio of 1.66. The company was free cash flow positive in Q1 2023 (for the third consecutive quarter). Operating an asset-light model, the company's CAPEX needs are minimal (USD 500,000 in Q1 2023 covered by operating cash flows of USD 9.4 million).

Risks

Changing consumer preferences

More than 96% of Vita Coco's product sales (including private label) are generated from coconut water, largely competing in the better-for-you hydration category which has no shortage of alternatives including flavored waters, and fruit juices. Some of these products may have certain advantages (in Western markets, barley, maple and birch water for instance have sourcing advantages and therefore cost and possibly marketing advantages as well over coconut water which is shipped from halfway across the world). If consumer preferences change for such alternatives, Vita Coco could be meaningfully affected.

Conclusion

Analysts are largely bullish on the stock.

Vita Coco's shares are up 114.7% over the past year and currently trades at a forward P/E of 35. This is higher than the sector median ( 18.55 ) but considering positive industry prospects, a market leading position and no meaningful competition, the premium could be considered fair and the stock could be viewed as a buy to some or a hold for others.

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