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The Science of Hitting
The Science of Hitting
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Dr. Pepper Snapple Group - Q3 2011 Earnings

October 26, 2011 | About:

Dr. Pepper Snapple Group (NYSE:DPS), the third-largest carbonated soft drink company in the world behind Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP), reported third quarter 2011 earnings on Wednesday morning. Unlike the two leaders in the industry, DPS is significantly weighted towards the U.S., which accounted for nearly 90% of the company’s revenues in 2010; here are some of the highlights from the 10-Q and the conference call:

Net sales increased 5% in the quarter to $1.53 billion, driven by price/mix (3%), an increase in sales volumes associated with contract manufacturing (1%), and the favorable impact of changes in foreign currency, favorable package mix and $7 million of revenue recognized under the Coca-Cola license arrangement in the quarter (1%). Year-to-date, sales are also up 5%, and have reached $4.44 billion through the first nine months of 2011.

In the Beverage Concentrates segment, sales increased 5% to $292 million. In the Packaged Beverages segment, which accounted for nearly three-fourths of quarterly revenues, sales increased 4.6% to $1.13 billion. Finally, in the Latin American Beverages segment, sales increased 8.2% to $105 million, with CSD volume up 4% in Mexico and the Caribbean.

Gross profit dollar was flat year over year at $857 million, while gross margin as a percentage of sales declined 280 basis points to 56%; as noted by CFO Martin Ellen on the call, this decline would have been even more impactful if it was not for pricing and ongoing supply chain efficiencies:

“First, higher overall input cost inflation increased cost of goods sold by almost $60 million, and reduced the year-over-year gross margin by 370 basis points. Next, this higher inflation also required us to record a $4 million LIFO inventory charge, as this method of accounting currently expenses these costs instead of capturing them in the inventory. This drove a further reduction in the gross margin comparison of 20 basis points, as there was no LIFO reserve addition last year in the quarter.

And finally, the reduction in certain commodity prices at the end of the quarter caused us to record $11 million of unrealized mark-to-market losses on commodity hedges, $9 million of which is in cost of goods sold and the rest is in SG&A. This reduction in COGS compares to a $4 million unrealized mark-to-market gain last year, resulting in a further gross margin reduction of 80 basis points. These items, all taken together, reduced year-over-year gross margins by 470 basis points.”

Among the items that caught my attention was the relatively little talk on Sun Drop (“Combined, our Core 4, Sun Drop and Crush brands were flat. Canada Dry continued this trend of double-digit growth, while Sun Drop added 2 million incremental cases on continued distribution gains.” [Grocery ACV is 92%, convenience is 56%]); this is a brand that, on the Q4 2010 call, the company said was “without a doubt, our big bet for 2011”. Now, the company barely mentions it in the prepared remarks, and simply says “it’s on track where we want it to be” when prodded for further analysis during the Q&A; I could be wrong, but it seems a bit odd to me and suggests that it might not be living up to the expectations originally envisioned (and points to the strength of the Mountain Dew brand – I might just be biased as a shareholder of PEP though).

Through the first nine months of the year, Net income was $440 million compared to $416 million in 2010 (with FCF at $475 and $400, respectively, after adjusting for taxes from the PepsiCo and Coca-Cola payments). The company has given back all of this and then some, with $425 million in share repurchases and $183 million in dividends paid year to date.

For the year, management still expects sales to increase 3-5%, with almost all of the gain coming from pricing (3%), the PepsiCo/Coca-Cola agreements, and currency (2%), combined with flat volume. Full-year EPS is still expected to be in the $2.70 to $2.78 range, suggesting EPS of $0.73-$0.81 in the fourth quarter compared to $0.82 in Q4 2010.

At the close, the stock was down more than 3.5%, and finished below $38 per share.

About the author:

The Science of Hitting
I'm a value investor with a long term focus.

As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, "Patience followed by pretty aggressive conduct."

I run a concentrated portfolio, with a handful of positions accounting for the majority of my equity holdings (currently two). From the perspective of a businessman, I believe this is adequate diversification.

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