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Dr. Pepper - Just What the Doctor Ordered
Posted by: Henry Tan (IP Logged)
Date: December 31, 2012 11:10AM
While the beverage industry is diverse with a breadth of choices, only a few large companies dominate the field. The competition in this industry is particularly fierce, with legions of loyal fans swearing fealty to their favorite beverage of choice. One juggernaut in particular, the Dr. Pepper Snapple Group (DPS), was a spinoff of Cadbury Schweppes with its IPO in 2008. A interesting tidbit about this company is that it's central base of operation is only a few miles away from GuruFocus! Based upon current conditions, a investment in the Dr. Pepper Snapple Group is recommended due to the company's growth prospects and the rather large margin of safety that exists due to its deviation from its intrinsic value.
In North America, there is a triumvirate of leadership in the beverage industry, which when ranked upon market capitalization, is as follows: Coca-Cola, Pepsi and Dr. Pepper. The Dr. Pepper Snapple Group has a large portfolio of household brands under its umbrella such as the "Core 5": Sunkist, 7-UP, A&W, Canada Dry and Sun Drop. In addition, the firm boasts of namesake brand such as Snapple and Dr. Pepper with the latter being its flagship brand. At its very core, as with most beverage companies, Dr. Pepper focuses on two customers, bottlers/distributors and retailers. They rely upon these channels to distribute their products to their final destination, the home of the average consumer. DPS believes that their tri-sector model "strengthens our route-to-market and provides opportunities for net sales and profit growth..." With that in mind, the firm has three core operational segments:
A. Packaged beverage - This segment relates to the sale of finished and packaged beverages in the U.S. and Canada. Sales in this segment exceeded $4 billion in 2011.
B. Beverage concentrate - Dr. Pepper brand concentrates are manufactured in St.Louis, Mo., and then shipped off to internal and external bottlers to mix and distribute among retailers. The Dr. Pepper line represents the majority of this segment. This segment had receipts exceeding $1.2 billion in 2011.
C. Latin America beverages - This segment focuses upon carbonated mineral waters, and other carbonated drinks in Latin America. Sales totaled $418 million in 2011.
Sales from the aforementioned segments are broken down via the following chart:
Relatively speaking, Dr. Pepper's third quarter earnings were neutral to negative. Overall volume was down, with bottler case sales declining by 2%. Receipts totaled in a rather flat manner, at $1.53 billion vs. $1.529 year over year in 2011. However, overall margins improved, as the firm posted a net profit of $179 million, with earnings at $0.84 per share. Comparatively speaking, in the third quarter of 2011, the firm posted a profit of $154 million with earnings totaling $0.73 per share. Cash on hand increased to $383 million from $303 million, and inventory declined by $10 million. Forward looking guidance dictated revenue growth of approximately 2% year over year, with earnings estimated between $2.90 to $2.98. Costs are expected to increase cost of goods sold by 2% due to packaging and ingredient costs. Furthermore, the firm is committed to repurchase approximately $400 million of common stock.
The chart above demonstrates that in the long term, Dr. Pepper is improving its productivity on several fronts. The reason for this improvement can be attributed to Dr. Pepper's commitment to its RCI (Rapid Continuous Improvement) plan. Based upon Lean Six Sigma principles, the Dr. Pepper Snapple firm has realized $103 million in savings since 2010, with a goal of $150 million by 2013. Ten warehouses have been closed, and routes were realigned in a manner in which 1 million traveling miles were eliminated. As such, a commitment to cut costs to this extent translates well for the bottom line and future investors.
Compared against the basket, Dr. Pepper trades at a lower multiple on several fronts, suggesting that it is undervalued. Unfortunately, on a cash basis, with respect to P/CF and EV/ FCF, the firm trades at a large premium to the average. As such, as reflected in the valuations utilizing multiples, Dr. Pepper is overpriced on aspects utilizing cash flow. However, the average valuation rendered through this methodology yielded a price target of approximately $63.82, which presents a potential upside of 45%.
"We could pay a higher level of dividend than we do today with no further positive change in our business model."
For the dividend investor, such a line from the CFO of the firm is largely positive. Since its first dividend of $0.15 in the fourth quarter of 2009, the firm has increased its dividend by 31% over the last three years. In terms of the payout ratio, the firm is paying out less than 50% of their earnings, which signifies growth in future dividend streams.
Dr. Pepper is a firm that has management committed to cutting costs, and delivering value to their shareholders. While it's true that sales have been stagnant at times, in the last few years, the economy has proved to be a challenger for firms across all industries. One must also consider that unlike other beverage companies, Dr. Pepper has a marginal presence in the European market. This proved to be beneficial as it allowed DPS to avoid the financial uncertainties there, while serving as a untapped market for future expansion. In terms of other opportunities, Dr. Pepper is rolling out five ten-calorie drinks next month, which caters to the more health-conscientious individual. As such, for the long-term investor, Dr. Pepper should be considered a buy to reap the rewards that are sure to come.
According to GuruFocus...
1. Ken Fisher currently owns 124,594 shares in his fund.
2. Joel Greenblatt currently owns 50,998 shares in his fund.
3. Mario Gabelli currently owns 2.7 million shares in his fund.
4. Robert Olstein currently owns 146,000 shares in his fund.