Keurig Dr Pepper: Now Showing Benefits From the Merger

This coffee and soft drink company has improving financials and a rapidly rising stock price

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Robert Abbott
Mar 17, 2021
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Keurig Dr Pepper (

KDP, Financial) was created in 2018 by the merger of two beverage companies, Keurig Green Mountain Inc. and the Dr Pepper Snapple Group Inc. With the merger, they brought together a coffee company and a soft drink company.

Although the deal is commonly referred to as a merger, what happened was the parent company of Keurig bought out the shareholders of Dr Pepper Snapple.

Since then, the new combined company has posted some unfavorable metrics; for example, new shares were issued to help finance the deal, leading to lower earnings per share and smaller dividends.

However, it appears the combined company is getting past the awkward stage, and investors have expressed their confidence by bidding up the share price.

About Keurig Dr Pepper

Keurig produces a single-serve coffee brewing system and sells specialty coffees in the U.S. and Canada. Dr Pepper produces the soft drink line that bears its name plus other beverages.

Under their combined banner, they also own Snapple, Canada Dry, Bai, Mott's, Core, Green Mountain and The Original Donut Shop.

The company reports in its 10-K for 2020 (published in February) that innovation is a key strategy, leading to new and better products. Last year, its research and development bore fruit in one closely-watched area: "We achieved our longstanding commitment to make all of the K-Cup pods that we produce recyclable, as the pods are now made from polypropylene #5 plastic."

Competition

The company provides the below list of competitors and the categories of competition (CSD=Carbonated Soft Drinks and NCB refers to Non-Carbonated Beverages):

Keurig Dr. Pepper competitors

Keurig Dr Pepper added, "Although these companies offer competing brands in categories we participate in, they are also our partners and customers, as they purchase beverage concentrates or K-Cup pods directly from us."

Competition among the companies is intense, and usually based on brand recognition, taste, quality, price, availability, selection and convenience. In addition, consumers are also swayed by corporate responsibility and sustainability (hence, the importance of recyclable pods).

Risks

The risks involved in owning Keurig Dr Pepper stock, from my view, include:

  • Pandemic risks, such as Covid-19 which has had an adverse effect on its sales to restaurants and financial results.
  • It competes with major multinational corporations, including those shown above. They have, in the company's words, "significant financial resources" and could cut prices or embark on marketing spending that Keurig Dr Pepper could not match..
  • Evolving consumer taste preferences affect the viability of individual products. These changes are driven by changing demographics, social trends, lifestyle changes, consumption patterns and more. Currently, issues include the caloric intake of soft drinks and the recyclability of packaging and pods.
  • With growing international sales, currency exchange rates are a continuing concern. In particular, the company is concerned with the U.S. dollar versus the Mexican peso, the Canadian dollar and the Euro.

Recent results

Despite the adverse effects of the pandemic in the first half of 2020, there was good news in the full-year 2020 results:

  • Net sales increased 4.5% year-over-year to $11.62 billion.
  • GAAP operating income went up 4.3% to $2.48 billion.
  • GAAP net income for the full year rose 5.7% to $1.33 billion; that works out to $0.93 per diluted share compared to $1.25 billion, or $0.88 per diluted share, in 2019.
  • The company reduced its financial obligations by more than $1.1 billion.

There were also several advancements in non-financial areas:

  • Its market share increased in more than 90% of its cold beverage markets.
  • The number of households using the Keurig coffee system grew by about 3 million.
  • It entered into a long-term agreement with Polar Beverages, a manufacturer and distributor of sparkling fruit beverages, seltzer, ginger ale, drink mixers and spring water.
  • The company transferred its stock exchange listing to the Nasdaq and joined the Nasdaq-100 Index.

With the fourth-quarter and year-end release, Keurig Dr Pepper advised that it expected strong sales growth again in 2021, enough to beat its target of 2% to 3% average annual growth.

Adjusted diluted EPS is expected to grow by double-digits in 2021 and meet the three-year merger target of 15% to 17% annual growth.

Financial strength

Keurig Dr. Pepper financial strength

We see from the table above that Keurig Dr Pepper receives a low 4-out-of-10 star rating for financial strength and is below recommended levels for some metrics on debt. However, if we put the debt in context, it seems the company has been reducing its long-term debt the last couple of years.

Keurig Dr. Pepper long term debt

The deal that brought the two companies together in 2019 involved $13 billion in borrowed funds. The company brought the debt down by $1.1 billion in 2020.

That debt reduction was one of two ways in which management signaled its confidence in the company's future. The second was a dividend increase, which will be coming up in April. It will boost the annual dividend from $0.60 to $0.75.

Profitability

Keurig Dr. Pepper profitability

The top half of this table is encouraging for investors, with good margins and a low but acceptable return on equity. However, the bottom three lines are problematic.

Again, though, the table points us in the wrong direction because it takes a longer period of history into consideration. This chart below shows how revenue ramped up after the merger (with analyst estimates for the future):

Keurig Dr. Pepper revenue chart

The picture looks much the same for Ebitda:

Keurig Dr. Pepper Ebitda chart

However, it's a different story again when it comes to earnings per share without NRI (orange line) and net income (blue line):

Keurig Dr. Pepper EPS and net income chart

Since net income continued upward after a one-year pause, but earnings per share did not, the difference must be in the number of shares that were available. Indeed, that's the case, as this chart of shares outstanding shows. Shares issued as part of the 2018 deal led to that dramatic change in earnings per share.Keurig Dr. Pepper shares outstanding chart

Dividend and share buybacks

Keurig Dr. Pepper dividend and share buybacks

As we've seen, Keurig Dr Pepper has been paying a dividend, and will increase it by 25% in the next quarter. However, at $0.60, the dividend was well below its pre-2018 value of $2.32 per share:

Keurig Dr. Pepper dividends per share

With the massive increase in the number of shares outstanding, the company obviously had to cut the dividend to remain solvent.

The current dividend yield is 1.76%, which is in the same general area as the average yield of the S&P 500 companies. It has a payout ratio of 65%, which is getting to the high end of the feasible range for companies that want to keep growing.

As for share repurchases, we saw in the chart above that the issuance of new shares ended in 2020 after two years of growth.

Valuation

The following is a 10-year price chart for Keurig Dr Pepper, and it initially appears the price has been range-bound since 2018:

Keurig Dr. Pepper 10-year price chart

However, on closer examination, using a year-to-date chart, we can see the price has risen rapidly in the past two weeks, from $30.62 on March 3 to $34.07 at the close of trading on March 16:

Keurig Dr. Pepper year-to-date price chart

That increase has been enough to generate a modestly overvalued rating from the GuruFocus Value Chart:

Keurig Dr. Pepper GuruFocus value chart

The price-earnings ratio is in line with that valuation; at 36.65, it is about 50% higher than the industry's 10-year median of 24.97.

Looking specifically at its two most prominent competitors, Coca-Cola (

KO, Financial) has a price-earnings ratio of 28.69 and Pepsico (PEP, Financial) has a price-earnings ratio of 26.11. On that basis, we can conclude Keurig Dr Pepper is more expensive than its rivals.

Over the past five years, the Ebitda growth rate has been negative, so the PEG ratio is not available, and because Keurig Dr Pepper has only 1-star predictability, a discounted cash flow value would be unreliable.

Gurus

Over the past two years, gurus have been selling the stock more than they have been buying it:

Keurig Dr. Pepper guru buys and sells

Of the eight gurus who hold positions in Keurig Dr Pepper, these are the three with the biggest stakes:

Nygren and his colleague

David Herro (Trades, Portfolio) of the Oakmark Global Fund had the following to say of the company in their fourth-quarter 2020 commentary:

"We believe that Keurig's brands should deliver steady growth, consistent market share gains and significant excess cash. We think the company is an above-average business trading at a meaningful discount to the broader market, its beverage peers and historical private market transactions."

Conclusion

It seems the vision that led to the merger of two beverage companies is coming to fruition. Sales and earnings are on the rise, as is the Keurig Dr Pepper share price. Investors have reasons to buy and hold the company, in my opinion.

That said, it is a pricey stock, with a price-earnings ratio that exceeds that of its two biggest rivals, Coca-Cola and Pepsico. Will the expected double-digit growth of earnings make up for a higher valuation?

Because the stock is expensive, value investors are not likely to be interested. The same goes for income investors who can find better dividend yields elsewhere. Growth investors may see opportunities for higher than average capital gains.

Disclosure: I do not own shares in any of the companies named in this article and do not expect to buy any in the next 72 hours.

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Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks. He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com). As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."