Keurig Dr Pepper Inc. (KDP, Financial) closed on May 6 at $31.86, near the 52-week low of $31.73. Bottom fishing is very risky for investing, but this beverage company has a story behind it that is based on profitability, an economic moat and strong earnings that justify a potential reversal now.
Investing is about weighing the risks versus the rewards to achieve well-adjusted returns. I argue that this leading beverage company, which was founded in 1981, is attractive now and not just a contrarian play.
Strong economic moats are supportive of future gains
The Plano, Texas-based company has a portfolio of over 125 brands that are either owned, licensed or are partner brands. The owned brands in the ready-to-drink market consist of well-known names such as Dr Pepper, 7UP, Sunkist and Schweppes, whereas in the ready-to-brew market it owns names like Green Mountain Coffee Roasters and Barista Prima. In the ready-to-eat market, the company owns Mott's brand. Its partner brands include Starbucks, Evian, Dunkin and Lipton.
Keurig Dr Pepper has several sustainable competitive advantages.
The first is strong brand recognition, allowing it to charge premium prices for its products.
It also has an effective distribution network. Beverage companies that have an extensive distribution network, working with wholesalers, retailers and other partners, can create a significant barrier to entry for new competitors. Building such a network takes time and a lot of investment, so established players in the market have a significant advantage in this regard.
Also working in Keurig Dr Pepper's favor is large economies of scale. The beverage industry is often characterized by high fixed costs, such as equipment, production facilities and marketing expenses. Established beverage companies that have achieved economies of scale can produce their products more efficiently and at a lower cost than new entrants, giving them an advantage in pricing and profitability. It is also effective in product innovation. Companies that continuously invest in research and development can stay ahead of the competition. By introducing new flavors, ingredients and packaging options, the beverage company can maintain consumer interest and demand, making it difficult for new entrants to gain market share.
Overall, Keurig Dr Pepper is a beverage company with a strong brand, extensive distribution network, economies of scale and a commitment to innovation. Further, it has proven it can establish and maintain an economic moat, providing a sustainable advantage over its competitors.
Further, the company excels at corporate responsibility, being named among the world’s most admirable companies in 2022 by Fortune magazine, one of America’s most responsible companies by Newsweek magazine and one of Canada’s top 100 employers for 2023. As many institutional funds seek to invest in companies that score highly on environmental, social and governance criteria, Keurig Dr Pepper appears to be a prime candidate.
A favorable industry outlook
According to Allied Market Research, the non-alcolholic drinks market was valued at $820 billion in 2020. Growing at a compound annual rate of 6.8%, it is projected to reach a value of $2.13 trillion by 2031.
The juice segment is anticipated to grow the most with a CAGR of 8.1% from 2022 to 2031, which is very positive news for Keurig Dr Pepper since it has 97 juices in its portfolio.
Additionally, the online retail segment is expected to witness a CAGR of 7.5% during the period due to the increasing number of mobile users. In this area, Keurig Dr Pepper has an advantage since it has invested in building a diversified e-commerce business via several channels, including Keurig.com, online grocery services and even other retailers' websites.
While Coca-Cola Co. (KO, Financial) and PepsiCo Inc. (PEP, Financial) will also benefit from this growth, Keurig Dr Pepper appears to have an edge due to its large number of popular drink brands.
Financials look good
Keurig Dr Pepper has a net income margin of 9.20% and a levered free cash flow margin of 12.26%, which exceed the consumer staples sector's median values of 3.16% and 2.69%. This indicates the company is performing very well in terms of profitability.
The company also has a debt-to-equity ratio of around 0.55, which is not excessive. Further, stockholder's equity grew from $23.83 billion in 2020 to $25.13 billion in 2022, indicating value was created. The growth in retained earnings is also positive for the last three years, increasing from $2.06 billion in 2020 to $3.54 billion last year.
Further, the revenue growth is very positive and the operating income trend is stable and rising, which is also evident in the cash flow from operating activities.
Keurig Dr Pepper delivered strong first-quarter reults, beating estimates for revenue and earnings per share. Revene grew 8.9% year over year to $3.35 billion, which was better than the consensus of $3.30 billion, while adjusted earnings of 34 cents topped expectations by one cent.
The sales trend was mixed in terms of geographic regions as the company increased its net sales for U.S. refreshment beverages by 12.7%, saw its U.S. Coffee sales decline by 1.3% and its international sales climb by 17.2%. The U.S. dollar exchange rate likely played a key role in this since the currency lost ground in the first quarter. Nevertheless, Keurig Dr Pepper reaffirmed its fiscal 2023 guidance for constant currency net sales growth of 5% and adjusted earnings per share growth of 6% to 7%.
Analysts covering the stock have mostly upgraded their recommendations to overweight, which is very bullish. I am also bullish on shares of Keurig Dr Pepper as its profitability is solid, the industry outlook is favorable and its strong economic moats can create significant upside potential.
