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Dr Pepper Stays Neutral

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On Sep 4, we maintained a Neutral recommendation on Dr Pepper Snapple Group Inc. (DPS - Free Report) as we have faith in its long-term fundamentals, despite consistently weak top-line results.

Why Kept at Neutral?

Dr Pepper’s second-quarter 2013 (results announced on Jul 24) adjusted earnings of 84 cents per share were in line with the Zacks Consensus Estimate. However, earnings decreased 1% year over year due to weak top-line performance as well as sluggish profits.

Net sales declined 1% year over year and missed the Zacks Consensus Estimate as gains from positive price/mix were offset by weak volumes. Both gross and operating profits declined due to weak sales, increased commodity costs (especially apple and corn) and higher marketing spend. Moreover, the company lowered its 2013 top-line guidance.

Volumes were hurt by the difficult operating conditions faced by the carbonated soft drinks (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 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.

Following the weak second-quarter results and the lowered sales outlook for the year, the Zacks Consensus Estimate mostly moved downwards. The Zacks Consensus Estimate for 2013 decreased 0.3% and that for 2014 went down 0.9% over the last 60 days.

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.

Moreover, following the success of the low-calorie version of its Dr Pepper brand of soft drinks, Dr Pepper TEN, the company 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. early 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 for the company versus peers like The Coca Cola Company (KO - Free Report) and PepsiCo, Inc. (PEP - Free Report) that 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 Pinnacle Foods Inc. (PF - Free Report) , carrying a Zacks Rank #1 (Strong Buy).

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