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Dr Pepper Kept at Neutral

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On Jun 20, we maintained a Neutral recommendation on Dr Pepper Snapple Group Inc. (DPS - Free Report) due to our faith in its long-term fundamentals, despite mixed first-quarter results.

Why the Neutral Recommendation?

Dr Pepper’s first-quarter 2013 adjusted earnings per share of 47 cents surpassed the Zacks Consensus Estimate by 12.8%. Earnings also increased 15.2% year over year on the back of strong margins and lower taxes, which made up for the weak top line.

Net sales grew only 1% year over year and missed the Zacks Consensus Estimate as gains from positive price/mix and lower discounts were offset by weak volumes.

Volumes were hurt by the difficult operating conditions faced by the CSD category in North America due to increasing health consciousness, slow consumer spending environment and abnormally cold weather conditions. Changing consumer preferences, increasing health consciousness, rising obesity concerns, possible new taxes to be levied on sugar-sweetened beverages and the growing regulatory pressures have transformed the CSD category to a sluggish growth category in North America. These category headwinds are significantly affecting Dr Pepper’s CSD volumes, which comprise around 80% of its business.

Despite volume concerns, we believe Dr Pepper has sound long-term fundamentals; commanding a strong position in the flavored CSD market and generating consistent cost savings and cash flow improvement under its Rapid Continuous Improvement (RCI) program. The ongoing productivity improvement program is boosting profits.

Moreover, following the success of the low-calorie version of its Dr Pepper brand of soft drinks, Dr Pepper TEN, DPS plans to expand its TEN platform to revive its 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. in early 2013. 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 for the company versus peers like The Coca Cola Company (KO - Free Report) and PepsiCo, Inc. (PEP - Free Report) , which are fast expanding outside the U.S.

Other Stocks to Consider

DPS carries a Zacks Rank #3 (Hold). A stock in the consumer staples industry that is currently performing well is Flowers Foods, Inc. (FLO - Free Report) , carrying a Zacks Rank #1 (Strong Buy).

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