A review of Coca-Cola (KO, Financial) operations revealed that it has been invested with Monster Beverage (MNST, Financial) since 2015. The investment has returned well for Coca-Cola, and it would be worthwhile to review Monster’s operations.
Read: Studying Coca-Cola's Recent Financials
Earnings performance
The $24.8 billion beverage maker reported its third quarter fiscal 2016 figures in November. For its nine months operations, Monster delivered a strong 10.5% sales growth to $2.3 billion and a further impressive 32.3% profit growth to $539.7 million for the period.
Shares of Monster traded four times in volume quantity and interestingly fell by 3.6% the day after, compared to the Standard & Poor's 500 index’s -0.2% change.
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"We commenced the launch of Monster Energy® drinks in China beginning with Beijing in September and Shanghai and Hunan Province in October. Further launches are planned in the fourth quarter and throughout 2017 in China. We also launched Monster Energy® drinks in Turkey in October. We commenced the transition to Coca-Cola bottlers in Brazil earlier this week and in the fourth quarter we will be transitioning to Coca-Cola bottlers in certain Central Asian, Latin American, Middle Eastern and African countries with further launches to follow in 2017.
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"In the U.S., we are continuing to see improvements in our quality of distribution. We launched MutantTM, our new Super Soda, in certain convenience store chains in late September 2016 with encouraging early results.
"The continued strength of the U.S. dollar as well as distributor transitions impacted our results."Â –Â Rodney C. Sacks, chairman and CEO
Meanwhile, Monster is set to report its next quarterly earnings on Feb. 23, according to Nasdaq.
Valuations
Monster is mostly overvalued compared to its peers. According to GuruFocus data, Monster had a price-earnings (P/E) ratio of 38.5 times (industry median 23 times), price-book (P/B) ratio of 7.3 times (industry median 2.6) and price-sales (P/S) ratio of 8.9 times (industry median 1.4). The company has not provided any dividends for the past decade.
Market performance
In the short term, Monster seemed to have failed its investors. According to Morningstar data, Monster’s one- and five-year total returns were -6.78% and 20.1%. On the other hand, the broader S&P 500 index returned 24.9% and 14%.
Monster Beverage
Monster was formerly known as Hansen Natural Co., which was originally founded in 1935. The beverage maker then changed its name to Monster Beverage Corp. in 2012 and entered an agreement with Coca-Cola in 2015Â that made the latter take ownership of Monster’s Hansen’s Juice Products and other nonenergy drink brands (3).
(Overview of Monster Beverages Primary Products, 10-Q)
In 2015, Monster Beverage had three reportable segments: Finished Products, Concentrate and Other. In second quarter 2016, however, Monster Beverage revised these operating segments into Monster Energy® Drinks, Strategic Brands and Other.
Finished Products
Monster Beverage’s Finished Products, which is comprised of the company’s Monster Energy® drink products, delivered 9% sales growth in fiscal 2015 and contributed 93%, or $2.52 billion, in total company sales. Finished Products also had a earning before tax margin of 33.2%, compared to 39.1% the year prior.
Monster Energy® Drinks formerly Finished Products
Quarterly figures for the revised Monster Energy® Drinks, which now included Mutant Super Soda drink products – some products were just introduced just last year – indicated a growth of 7.3% in sales while contributing 90% in total sales for the recent nine months fiscal 2016 operations.
Monster Energy® Drinks also delivered an earnings before tax margin of 42.2%, compared to 30.9% year on year.
Concentrate
Monster Beverage’s Concentrate segment included the various energy drink brands acquired from Coca-Cola. According to Bloomberg, these drink brands included the once Coca-Cola energy drinks NOS, Full Throttle, Burn, Mother and Play to Monster.
In fiscal 2015, the Concentrate had $143.3 million in sales and delivered an earnings before tax margin of 62.7%. There were no previous financial figures since the Coca-Cola agreement occurred in 2015.
Strategic Brands formerly Concentrate
For its recent nine months of operations, the newly termed segment – Strategic Brands –delivered a 150.9% sales growth and contributed 9% of total Monster Beverage sales. The segment also had a pretax profit margin of 61.1%Â –Â highest among the three segments – for the period.
Other
Monster Beverage’s Other segment included brands disposed of as a result of its Coca-Cola transaction which previously comprised the majority of the former Warehouse segment and the Peace Tea® brand, according to recent filings.
In 2015, the Other segment had negative 60% change in sales and contributed 2% in total sales with a pretax profit margin of 272%. Nine months into fiscal 2016, the segment had another negative 80% loss in sales compared to the year prior and delivered a pretax margin of 12.6%.
Overall, five-year sales and profit growth and operating margin averages for Monster Beverages were 15.9%, 20.9% and 28.4% (1).
Cash, debt and book value
As of Sept. 30, 2016, Monster had $599 million in total cash and $0 debt. The company also had about 56% of its $4.24 billion in total assets in goodwill and intangibles. Monster also had a book value of $3.4 billion compared to $4.7 billion the year prior (1).
Cash flow
(10-Q, Monster)
Nine months into fiscal 2016, Monster improved its cash flow from operations by 19.6% to $420.7 million. In addition to Monster’s impressive profit growth, the beverage company saw cash flow coming in from increase in inventories, accrued promotional allowances and deferred revenue.
According to Morningstar data, capital expenditures were $72 million leaving Monster with $349 million in free cash flow, compared to $17 million the year prior. In addition, Monster received $892.5 million inflows from its previously held-to-maturity investments while also allocating $378.3 million in similar investments.
In April 2016, Monster engaged in a "modified Dutch auction" tender offer and repurchased $2 billion worth of its total outstanding shares. According to company filings, Monster paid $156 per share on average on this auction.
In review, Monster actually issued $1.2 billion* worth of shares in 2015 in connection with its Coca-Cola transaction, where the latter bought near 17% of Monster and both had agreed to transfer rights between its energy and non-energy businesses (2). The recent overpriced buyback may have been done to offset most of the issued shares during the Coca-Cola transaction.
For its recent operations, Monster also acquired a flavor supplier and also a long-time business partner, American Fruits & Flavors, for $688.5 million.
Through all of these important acquisitions and business arrangements in recent times, Monster did not take in debt but instead made principal payments of $1.73 million. Monster also had issued $10.6 million worth of common stock in the recent period.
Conclusion
Monster Beverage’s and Coca-Cola’s arrangement certainly is unique. Why would Coca-Cola just buy Monster outright is still a good question. Coca-Cola had $25.6 billion in cash and short-term investments as of September, while Monster’s market capitalization was at $25 billion as of Wednesday.
Conservative investors would think twice, too, in overlooking Monster Beverage’s balance sheet. Despite having more than half of its assets in goodwill and intangibles, the company carried no debt. Cash flow, meanwhile, seemed to be in a bit of disarray given its recent transactions.
Some few weeks ago, analysts at Wells Fargo (WFC) maintained its rating for Monster at market perform with a valuation range of $44 to $46 a share, according to Barron's.
(Monster Beverage Share Price at $43.13 with a trailing P/E ratio of 38.5 times, GuruFocus)
Meanwhile, historical earnings multiple and growth averages accompanied by a 20% margin indicated a value of $37 a share.
In summary, Monster is a pass.
Notes
(1) Morningstar data.
(2) *Coca-Cola press release: Coca-Cola made a net cash payment of approximately $2.15 billion to Monster.
Disclosure: I do not have shares in any of the companies mentioned.
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