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Patricio Kehoe
Patricio Kehoe
Articles (164) 

Jim Simons’ Take on the Soft Drink Industry

November 12, 2013 | About:

The non-alcoholic beverage industry is very tough, especially for those seeking to compete with giants Coca-Cola Enterprises Inc. (NYSE:CCE) and PepsiCo Inc. (NYSE:PEP). Yet market share can still be obtained, as new niches create fresh opportunities for smaller developers such as Monster Beverage Corporation (NASDAQ:MNST) and Dr Pepper Snapple Group Inc. (NYSE:DPS). As investment guru Jim Simons has been quite active in this industry, let’s take a look at these assets he currently holds.

Good Prospects, but Overpriced

Through its large network of subsidiaries, Monster Beverage develops and sells a wide range of non-alcoholic beverages. Energy drinks, natural sodas and fruit juices are some of the firm’s key products. Despite its different offerings, the company derives 92% of its revenue from energy drinks, with Monster Energy Drink as its flagship beverage.

As Monster Beverage seeks to cash in on its position as the second-largest supplier of energy drinks behind Red Bull, new marketing efforts have been made. These have resonated with customers throughout the U.S., resulting in a huge revenue increase, from $50 million in 2003, to a whopping $1.9 billion in 2012.

The domestic market can still offer good returns, especially due to the company’s asset-light business model, which uses third-party manufacturers for the production of its energy drinks. This interesting business strategy will allow the firm to achieve returns on invested capital above the 50% mark over the next five years, far above the average achieved by Coca-Cola, which lies at 22%.

These enormous returns are expected to be held up by a modest annual increase in per capita consumption of 3% to 5% in the U.S., while expansion overseas could lead to further increases in revenue. Since Monster Beverage is only active in 80 countries, there is yet much room for expansion, with international sales projected to make up around 50% of sales by 2020 (currently at 21%).

Despite a healthy financial position, and plans for international expansion, there are also risks involved when investing in Monster Beverage. The firm’s largest distributor, Coca-Cola, is also an industry rival and could seek higher economic rent from the energy drink developer. Also, the stock is currently trading at 29.9 times its trailing earnings, entailing a significant price premium relative to the industry average of 20.3, which means time for entry has long passed. Despite Jim Simons’ sale of around 96% of his Monster Beverage shares, I cannot help but feel somewhat optimistic about this company’s future. The opportunities which arise from international expansion, along with the firm’s impressive growth record, have me feeling bullish regarding the firm’s future prospects.

Lack of International Exposure and Small ROIC [/b] Dr Pepper is a non-alcoholic beverage manufacturer and distributor, which does most of its business in North America. With brands such as Dr Pepper, Snapple, Mott’s 7UP, Canada Dry, Hawaiian Punch, A&W and Crush, the company has a foot in both the carbonated and non-carbonated beverage markets. Since around 93% of revenue is generated in the U.S. and Canada, the firm is looking to increase its marketing spending, and expand its distribution network.

As per capita consumption increases at a moderate pace, Dr Pepper is bound to profit from its 16% share of the U.S. soft drink market. Ramping up marketing and distribution are seen as key elements for the company’s future outlook, hence, proper execution will be crucial if any success is to be derived from these new strategies. Investments in coolers for example, are expected to result in an increased coverage of single-serve channels, which are highly profitable. However, Dr Pepper lacks the scale of its larger competitors, and has projected returns on invested capital of only 16.5%. This means the firm will not be able to take full advantage of the popularity of its products, resulting in a slower growth rate compared to rivals Coca-Cola and PepsiCo.

The lack of exposure to emerging markets, and overall absence from international markets, will also take a toll on Dr Pepper’s future prospects. Although the company could still venture into new markets over the coming years, there are currently no plans for any such operations, leading me to question the firm’s business strategy.

Investment guru Ken Fisher seems to have a similar dilemma with the company, as he recently sold his entire stake in the firm. Jim Simons also sold a large part of his shares as of late, leading me to further doubt the company’s ability to fend off competitors and maintain margins. Although Dr Pepper offers an attractive 3.09% annual dividend yield, and its finances look very good, projections of future growth are what this soft drink manufacturer is missing. Overall, I feel bearish regarding Dr Pepper’s future.

[b]What Jim Simons Fails to See

Although I usually would not dare argue with the decisions of investment guru Jim Simons, I think his recent sale of Monster Beverage shares was not the best move. The firm has solid growth prospects, and has focused on a niche left pretty much open by larger competitors Coca-Cola and PepsiCo. Although it must still compete with Red Bull, which currently dominates the market, I feel bullish about Monster Beverage’s ability to manage a successful international expansion strategy, and continue on its growth path.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

Rating: 4.1/5 (8 votes)


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