On Nov 25, we maintained a Neutral recommendation on Dr Pepper Snapple Group Inc. (DPS - Analyst Report) as we have faith in its long-term fundamentals, despite consistently weak top-line results.
Why the Neutral Recommendation?
Dr Pepper’s third-quarter 2013 (results announced on Oct 23) adjusted earnings of 88 cents per share beat the Zacks Consensus Estimate of 83 cents by 6%. Moreover, earnings increased 11% year over year due to pricing gains, productivity improvements, a lower tax rate and a LIFO inventory benefit.
However, sales continued to be soft due to weak volumes. Net sales increased 1% year over year but missed the Zacks Consensus Estimate as gains from positive price/mix were offset by weak volumes. Operating income improved 3% in the quarter due to productivity improvements and LIFO inventory benefit of $14 million.
Volumes were hurt by the difficult operating conditions faced by the carbonated soft drinks (CSD) category, both regular and diet, in North America and slow consumer spending environment. Changing consumer preferences, increasing health consciousness, rising obesity concerns, possible new taxes to be levied on sugar-sweetened beverages and the growing regulatory pressures are tremendously pressurizing the CSD category in the region. These category headwinds are significantly affecting Dr Pepper’s CSD volumes which comprise around 80% of its business.
Moreover, the company lowered the 2013 top-line guidance for the second time this year due to CSD category headwinds.
Despite volume concerns, we believe Dr Pepper has sound long-term fundamentals; commands a strong position in the flavored CSD market and generates consistent cost savings and cash flow improvement under its Rapid Continuous Improvement program.
Moreover, following the success of the low-calorie version of Dr Pepper brand of soft drinks, Dr Pepper TEN, the company expanded its TEN platform to revive the CSD category growth. Accordingly, the company launched TEN versions of 7UP, Sunkist Orange Soda, A&W Root Beer, Canada Dry Ginger Ale and RC Cola brands in the U.S. earlier this year. However, we prefer to remain on the sidelines as we believe the new initiative will take some time to deliver substantial results.
Moreover, DPS’ lack of exposure in the fast growing emerging markets is a significant competitive disadvantage as peers like The Coca Cola Company (KO - Analyst Report) and PepsiCo, Inc. (PEP - Analyst Report) are fast expanding outside the U.S.
Other Stocks to Consider
Dr Pepper carries a Zacks Rank #3 (Hold). A better ranked beverage company is Coca-Cola Amatil Limited (CCLAY), which carries a Zacks Rank #1 (Strong Buy).