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Cries can be heard across the country for the Head of Monster Beverage Corporation (NASDAQ:MNST) for its purported connection to the deaths of six people (New York Times). With Mayor Bloomberg in New York already on the offensive against soft drink makers, many worry there might be a spillover into the energy drink market. Fear has riddled the sector and depressed the company's stock price to levels not seen in a year, right before the stock began a meteoric 63% gain in value over a five-and-a-half month period. What follows is an argument and evidence to show why shares are deeply undervalued.

Lawsuits and Liabilities

First to address the gorilla in the room, the claim by many activists that Monster's beverages played integral roles in the deaths of six people who had consumed beverages the company produces. While there is no disputing that there is a common factor among them all, it is important to note that in at least one of the six cases, the deceased had previous medical conditions that were at play, not just the consumption of Monster energy drinks. No details are available with regards to the other five incidences citing the involvement of Monster beverages. The company does protect itself to the extent of placing disclaimers on the side of the can to specifically say that no one should consume more than three in a day, and that the drink is not intended for use by children or those sensitive to caffeine.

To set the investor's mind at ease for the near term, solace can be found in the rate at which wrongful death lawsuits have progressed against tobacco companies. Even with the plethora of data gathered against the tobacco industry, plaintiffs still struggle to mount successful offensives. With only the recent explosion in the popularity of energy drinks, the relative infancy of the industry doesn't lend itself well to determining any cause and effect correlation.

Competitor Caffeine Comparisons

Further reason to believe the court systems will rule in favor of Monster lies in the comparison of Monster beverages with other popular drinks being sold on the market. On both a per ounce and per container comparison, caffeine levels in Monster energy drinks pale in comparison to coffee house and prepackaged coffee drinks.

BeverageContainer SizeCaffeine per ContainerCaffeine per Ounce
Monster Nitrous12oz160mg13.3mg
Monster Rehab Energy Drink16oz170mg10.6mg
Monster Assault16oz160mg10mg
Java Monster15oz160mg10.7mg
Rockstar16oz160mg10mg
Rockstar 2x Energy Drink12oz250mg20.8mg
Rockstar Juiced16oz160mg10mg
Full Throttle Energy Drink16oz140mg9mg
Red Bull8.46oz80mg9.5mg
Starbucks Grande Coffee16oz330mg20.6mg
Starbucks Doubleshot6.5oz130mg20mg
Dunkin' Donuts Coffee10oz132mg13.2mg
Baskin' Robins Cappuccino Blast24oz234mg9.8mg
5 Hour Energy Shot2oz138mg66mg
AMP Energy Boost Original16oz.142mg8.9mg

*Full Throttle is produced by Coca-Cola (NYSE:KO), Baskin' Robbins is a division of Dunkin' Donuts (NASDAQ:DNKN), and AMP is produced by PepsiCo (NYSE:PEP).

It would be impossible to attack caffeine levels in Monster beverages without also attacking other major beverage manufacturers. What may be more likely is regulation from the FDA setting limits on the caffeine density of beverages. Similar limits are already in place for soft drink manufacturers, with limits of 71mg of caffeine per 12 ounces. With 5 Hour Energy being named as a potential link to 13 deaths (New York Times), and having a 66mg/ounce caffeine ratio, the FDA may look to "appease" those looking for more to be done on their part. The FDA continues to explore and evaluate a variety of ingredients, including caffeine, in energy drinks; however, to this point many are deemed as "Generally Recognized as Safe."

Industry Leader and Growing

According to BevNET, Monster Beverage controls about 37% of the energy drink market share, trailing only behind Red Bull (42% market share) and well ahead of Rockstar whose market share comes in at a paltry 11%. What do these top three companies have in common? Neither of the three is in any way associated with either of the "beverage industry titans," Coca-Cola or Pepsi. Instead these two have decided to duke it out with each other using their own in-house brands, Pepsi with its AMP energy drink (4% market share) and Coca-Cola with Full Throttle (0.5%).

Despite trailing by 5% in market share, Monster has recently picked up the pace, with Nielsen ratings saying that during the most recent 13 week window, ending October 20th, Monster energy drink sales increased 19.5% versus Red Bull's 16.6%. AMP sales swung to a 9.8% decline while Full Throttle Sales bounded higher by 9.1%. Interesting to note is the growth in "Coffee plus Energy" drink sales. Monster's "Java Monster" experienced sales growth of 23.3% year over year in the third quarter of 2012. This was more than 3% faster than the 2011 year over year growth rate. With growth accelerating, this may cushion the companies' margins as coffee prices have decreased significantly from 2011.

While seeing sturdy double digit growth in sales on the home front, Monster has seen sales explode internationally as it pursues an effort to expand its distribution reach. Year-over-year results showed Monster's Mexican distributor reporting sales 46% higher. Excluding the effects of a strengthening U.S. dollar, sales in Europe, Asia and Africa combined were 65.4% higher versus the same quarter in 2011.

To continue its organic growth, the company launched its products in the Philippines and Turkey and expanded its product base in Ukraine. The company plans to initiate product launches in Chile, Peru and Singapore during the fourth quarter and Argentina and Taiwan in 2013. Along with these planned launches, the company stated in its third quarter conference call that while it had taken a few months longer than initially scheduled, a launch into South Korea is also imminent. These expansions will be coming on the heels of second quarter expansions into Japan, Macau, Hong Kong and Slovenia.

Outside of South Korea, Monster has experienced only a few hiccups during its global expansion. One example being in Japan where distributors hold stricter requirements for the shipments they are willing to receive. The occasional hiccup is something the company is certainly willing to deal with, especially with sales in Japan continuing to exceed the company's expectations.

Further details about Monster's global expansion can be found in its most recent conference call transcript here, as well as the company's investor relations webpage.

Acquisition Rumors

During MNST's 63% run up in value about a year ago (referenced at the very beginning), rumors flew in every direction about Monster being a potential takeover target with Coca-Cola's name being brought up (Wall Street Journal) on several occasions along with Anheuser-Busch (NYSE:BUD). These rumors very well could have been the reason the stock ran to its $80+ all time high. Albeit this was short lived as once everyone began to accept the fact that the rumors were just that, the stock promptly retreated. While I am not usually one to poke the bear, at the current market price, ~$45/share, a takeover of Monster is not a completely absurd proposal.

Will it occur within the next 3 to 6 months? Highly unlikely. Any suitor that is going to consider paying north of $9 billion for this company is going to wait until after the FDA, and congress, make their decisions about the fate of the energy drink market.

Final Say

For the trailing twelve months, Monster has recorded over $2 billion in sales. It continues to expand its global distributions and has done so while continually growing sales, and at times at a rate faster than the market share leader (Red Bull). Fully anticipating a clean bill of health from this whole lawsuit/FDA inquisition fiasco, I expect Monster shares to rally from the current price level to $55 where the company would be valued at slightly less than $9.5 billion (4.25x sales).

Analysts covering the stock believe the company will see revenues increase 23.8% over the next year and earnings growing at 19% over the next five years (FinViz). Presuming, conservatively, that the company can only grow revenues at 19% this year, and if that rate of growth were to decrease 3% each year for the next 5 years, the present value of future cash flows comes to approximately $55.60, further supporting my price target of $55/share.

Source: Monster Beverage Considerably Undervalued

Additional disclosure: I am long both MNST and DNKN Call Options