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Near-Term Outlook for the Soft Drinks Industry Lacks Fizz

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The Zacks Beverages - Soft drinks industry covers companies that manufacture, source, develop, market and sell non-alcoholic beverages. Makers of sparkling soft drinks, natural juices, enhanced water, sports and energy drinks, dairy, and ready-to-drink tea and coffee come under this category. Apart from marketing beverage, some players in this industry sell food and snacks to complement their beverage portfolio. Soft drink behemoth, PepsiCo, Inc. (PEP - Free Report) is one such company operating worldwide.

Companies sell products through a network of wholesalers and retailers, including supermarkets, department stores, mass merchandisers, club stores, and other retail outlets. Additionally, some of them offer their products via company-owned or controlled bottling, independent bottling partners and partner brand owners.

The soft drinks industry holds a significant position in the U.S. beverage market. A report by Grand View Research, Inc. reveals that the U.S. soft drinks market is likely to reach $388.4 billion by 2025. This indicates a CAGR of 5.1% through 2025.

Here are the three major industry themes:

  • While demand  in the soft drinks industry is strong, the carbonated soft drinks (‘CSDs’) category continues to witness unfavorable trends. Notably, soft drinks makers have tried to boost sales of diet and no sugar variants of their drinks through the introduction of new flavors. However, the core category suffers due to increased consumer awareness about health and wellness. The health hazards associated with the consumption of these drinks have dented demand in most markets. Clearly, a complete transformation of the carbonated drinks portfolio will take time and will continue to remain a drag on volumes in the near term. On the flip side, the rising demand for health and non-carbonated drinks calls for huge investments on part of the industry players that might hurt their profits initially.
  • Soda and beverage companies have been witnessing higher input costs for over a year now, particularly due to the imposition of 10% tariff on imported aluminum that is used for making cans. The lifting of import taxes on steel and aluminum from Canada and Mexico in mid-May by the U.S. government, in order to clear the roadblock in the North American trade pact – U.S.-Mexico-Canada Agreement (USMCA) – signed in 2018, is a breather for the beverage companies. With the easing of these taxes, beverage companies are expected to have enough capital for innovation, product development and expansion. This is also likely to relieve some burden from the profit and loss statements of the beverage companies, which were incurring increased costs due to rising tariffs. However, tariff pressure on imports and exports to Europe and other countries lingers. Additionally,  impacts of escalated freight costs and higher SG&A expenses will continue to increase operating expenses, which will affect the companies’ margins and profits. Further, adverse foreign currency risk is plaguing the soft drinks industry, given worldwide operations of the companies. Although soft-drink makers are resorting to cost-containment efforts and price increases, these bottlenecks will continue for a while.
  • Conversely, rebranding and making innovative changes to existing drinks’ portfolio to suit consumer taste and the introduction of healthy and non-carbonated beverages may lead to gains. Industry players are introducing new flavors for health drinks by revamping existing products, acquiring new brands, product innovation and roll outs. Other product categories targeted by players to better restructure their portfolios, include sports nutrition, sparkling water, dairy, iced tea, juices and coffee. The burgeoning popularity of cannabis-infused drinks, which can be an attractive alternative to sugary sodas, is also luring companies.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Beverages - Soft Drinks industry is housed in the broader Consumer Staples sector. It carries a Zacks Industry Rank #224, which places it in the bottom 12% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimates for the current year have declined nearly 20%.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Versus Broader Market

The Zacks Beverages – Soft Drinks industry has underperformed both the S&P 500 Index and the Consumer Staples sector in a year’s time.

While the industry has gained 4%, the S&P 500 has advanced 5.8%. Meanwhile, the sector has registered growth of 4.1% in the said time frame.

One-Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings (P/E), which is commonly used for valuing soft drinks stocks, the industry is currently trading at 23.65X compared with the S&P 500’s 18.39X and the sector’s 19.58X.

Over the last five years, the industry has traded as high as 25.10X and as low as 19.88X, with a median of 22.26X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)

Bottom Line

While efforts to add healthier beverages and strategic buyouts build optimism for the soft drinks industry, CSD category headwinds, and higher input and operating costs cannot be ignored. Furthermore, a complete transformation of the carbonated drinks portfolio will take time and remains a drag on volumes. An unimpressive Zacks Industry Rank also signifies bleak prospects.

None of the stocks in the Zacks Beverages – Soft Drinks space currently sport a Zacks Rank #1 (Strong Buy). Despite the near-term hurdles, the industry has two stocks carrying a Zacks Rank #2 (Buy), which are well poised for growth. We suggest two other stocks with a Zacks Rank #3 (Hold) that investors may hold on to. You can see the complete list of today’s Zacks #1 Rank stocks here.

Let’s have a look at them.

Monster Beverage Corporation (MNST - Free Report) : This leading distributor of energy drinks and alternative beverages has gained 8.7% in a year. The Zacks Consensus Estimate for this Zacks Rank #2 company’s EPS has been revised 1% upward over the past 60 days.

Price and Consensus: MNST

Keurig Dr Pepper Inc. (KDP - Free Report) : This beverage and coffee company has surged 22.4% in the past year. The Zacks Consensus Estimate for this Zacks Rank #2 company’s EPS has been stable over the past 30 days.

Price and Consensus: KDP

The Coca-Cola Company (KO - Free Report) : Shares of this soft-drinks behemoth have advanced 15.5% in a year. Moreover, the Zacks Consensus Estimate for this Zacks Rank #3 company’s current-year EPS has remained stable in the past 30 days.

Price and Consensus: KO

PepsiCo: Shares of this leading food and beverage company have gained 17% in the past year. The Zacks Consensus Estimate for the current-year EPS has been stable over the past 30 days. It carries a Zacks Rank #3.

Price and Consensus: PEP

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