Energy drinks may seem like a great growth market for non-alcoholic beverage firms. But investors should exercise caution before buying in. Whether true or false, there are many suspicions and allegations about health problems associated with energy drinks. Investors should require low valuations to compensate for this bad publicity and any legal risks that may come from these tragic events.
Health Issues for Red Bull
The U.S. Food and Drug Administration released a list of reported health problems which were somehow associated or connected to energy drinks. Problems that coincided with consuming energy drinks included increased heart rate and abdominal pains. With incidents dating back to 2004, the report included incidents associated with drinks like 5-Hour Energy, Monster Beverage (NASDAQ:MNST) and Rockstar.
In summary, 5-Hour Energy drink was linked to 92 incidents that included 33 hospitalizations and 13 deaths. Red Bull was mentioned in 21 event reports, including four incidents of hospitalizations. Monster drink had 40 reports, including five fatalities and 20 hospital check-ins. Rockstar recorded no fatalities, but was identified in 13 incidents. Though it could be found that there is no meaningful connection between these medical issues and the consumption of energy drinks, there is a risk that some connection could be established.
The U.S. Food and Drug Administration requires U.S. beverage companies to indicate caffeine levels are safe if they exceed a certain concentration. The FDA said that the common soft drink should contain no more than 71 milligrams of caffeine in every 12 ounces to ensure safe caffeine levels. If caffeine is more concentrated, it is required to be reported. A Red Bull energy drink has 80 mg of caffeine.
Nothing has been proven so far, and any connections are no more than allegations or speculation at this point. Regardless, this bad press does not make you want to gulp down a Monster energy drink.
Bad PR Under Monster's Bed
Monster Beverage stock plunged by 11% upon the announcement of disappointing third-quarter sales. The news was good, but worse than expected. Third-quarter income increased to $86.1 million by 4.6% year-over-year, up from $82.6 million. Sales missed the analysts' average estimate by 14% at $578.4 million. This was Monster's slowest period for revenue growth since 2010.
Why did sales growth slow down? The fall in revenue is blamed on bad press that has come from five people dying after drinking Monster energy drinks over the past year.
The investigations conducted by the U.S. Food and Drug Administration have exonerated the company. No link was found between the deaths and the beverage consumption. Monster Beverage CEO Rodney Sacks stated that there is no evidence connecting the beverages to these tragic events. He said, "There is not a shred of information which causally links Monster to these adverse events."
New regulations may be spawned from these tragic events. Senators Richard Blumenthal of Connecticut, and Richard Durbin of Illinois, demanded that the FDA clarify whether energy drinks qualify as dietary supplements.
Pepsi Going Flat
The question of health issues surrounding energy drinks is not the only challenge facing non-alcoholic beverage stocks. Some beverage companies are having a hard time growing. PepsiCo (NYSE:PEP) experienced a 5 percent drop in net income versus the third quarter of 2011. Sales also dropped 5.3 percent between the period.
But these results were widely regarded as good news as they beat analyst expectations. PepsiCo CFO Hugh Johnston stated, "I expect to see, with our balanced portfolio, continued growth in our core beverage business."
Regardless of how these results were presented, they were not growth. Investors should not pay above-market price multiples for declining earnings and sales.
A Bumpy Ride for Coca-Cola Femsa (NYSE:KOF)
Is there revenue growth and earnings growth made possible by overseas expansion? Yes. However, investors should be warned that this growth is found in volatile markets.
Mexican bottler Coca-Cola Femsa reported strong numbers for its third quarter. Revenue grew 20.3% year-over-year. Sales from existing territories increased 9.6%. Increases in operating margins made combined operating income grow even faster at a rate of 26.6%. Better margins widened operating income from existing territories, which increased 18%. There was growth in the bottom line as well, with controlling interest income growing 53.5% for the third quarter. CEO Carlos Salazar Lomelin said, "After facing a very tough commodity and volatile currency environment over the past several quarters, we look forward to a strong close of the year."
The third quarter was a dream compared with the nightmare seen in the second quarter of 2012. Coca-Cola Femsa's second-quarter profits came in 8.4% below analyst estimates. American investors were disappointed in their Coca-Cola Femsa positions based on a weakening peso, which slid by 12% against the dollar. Net income fell 9 percent with the cost of labor and freight increasing in Argentina and Venezuela, which pushed theses expenses up by about 38%. Chief Financial Officer Hector Trevinor said, "Should currency volatility recede, we look forward to a more stable cost environment for the second half of 2012."
The company is also moving into Asia. Coca-Cola Femsa is expanding beyond Latin America with a Coca-Cola unit in the Philippines.
Monster is not trading at a discount:
Dr Pepper Snapple
The market is pricing in significant growth for Monster, and it trades at valuations that rival or exceed Coca-Cola FEMSA. Unfortunately, the growth prospects of energy drinks are in danger, much more so than growth in emerging markets.
At today's market prices, only Dr Pepper Snapple (NYSE:DPS) trades at reasonable valuations. The firm's 1.56 price-to-sales ratio is in line with today's prevailing market multiples. Dr Pepper Snapple stock also trades at a fair 15.35 price-to-earnings ratio, in line with the S&P 500 average.
Other stocks in this space are a little pricey. PepsiCo and Coca-Cola (NYSE:KO) trade at price multiples that are higher than those of the S&P 500 index. Investors have no reason to overweight these stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.