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Monster Beverage Corp. (MNST) is set to report Q1 2013 earnings results on May 8th alongside Green Mountain Coffee Roasters (GMCR) after the closing bell. In the company's most recent earnings release, MNST failed to meet analysts' expectations for the second sequential quarter. Let's take a look at the firm's most recent results before moving forward:

  • Net sales of $471.5 million, up 15% vs. a year ago
  • Diluted earnings per share of $0.39 a share vs. $.35 last year
  • Gross sales in October 2011 grew 31.1% YOY
  • Gross sales outside of the U.S. were $115.2 million vs. $88.9 million a year ago
  • Gross profit margin was 51.7% in the quarter vs. 52.3% a year ago
  • Effective tax rate was 39.1% in the quarter vs. 38.3 a year ago
  • Inventories were $203.1 million vs. $155.6 million a year ago

Now let us look at both analysts' expectations for Q1 2013. Below is a table of current analysts' estimates provided by Capital IQ:

Earnings Est

Current Qtr.
Mar 13

Next Qtr.
Jun 13

Current Year
Dec 13

Next Year
Dec 14

Avg. Estimate

0.46

0.68

2.26

2.68

No. of Analysts

8.00

8.00

10.00

10.00

Low Estimate

0.44

0.63

2.08

2.36

High Estimate

0.49

0.72

2.40

2.95

Year Ago EPS

0.41

0.59

1.86

2.26

Revenue Est

Current Qtr.
Mar 13

Next Qtr.
Jun 13

Current Year
Dec 13

Next Year
Dec 14

Avg. Estimate

501.74M

658.90M

2.32B

2.63B

No. of Analysts

7

7

9

9

Low Estimate

497.00M

643.10M

2.27B

2.48B

High Estimate

510.54M

671.05M

2.38B

2.77B

Year Ago Sales

454.60M

592.64M

2.06B

2.32B

Sales Growth (year/est)

10.40%

11.20%

12.70%

13.10%

Energy Drink Sentiment

The story is much the same over the last 6 months for Monster Beverage Corp. and its respective shareholders. The scrutiny over caffeinated drinks has cast a cloud over energy drinks and much of the focus has come at the expense of Monster Beverage drinks. Most recently, the company has fired back at San Francisco's city attorney over demands that the energy drink maker reduce caffeine in its beverages and stop marketing to minors. The U.S. Food and Drug Administration, not the city, regulate Monster's labels and drinks and San Francisco's demands violate U.S. free speech and Interstate commerce laws, lawyers for the company said in a complaint filed in federal court.

I would argue that Monster's retaliation will not only be in vain, but will come at the costs of shareholders who will undoubtedly foot the bill for this and any lawsuit the company engages in. What Monster will not be able to do with this lawsuit is displace the scrutiny that continues to mount over the energy drink category. 5 Hour Energy has embarked on its very own retaliation toward the scrutiny of the energy drink category in commercial advertisements that tout the fundamental efficacy of energy drinks and shots and compare the caffeine content to that of the average cup of coffee.

While Monster and other energy drink producers maintain that there is no connection between energy drinks and health issues, others continue to disagree. Most recently, the American Heart Association spoke out in conjunction with their latest study finding that energy drinks may increase blood pressure and disturb the heart's natural rhythm.

In spite of the multitude of concerns surrounding the efficacy and adverse affects of energy drinks, investors should consider the CEO's latest remarks concerning the strength/weakness of the energy drink category. During MNST's latest conference call with analysts, Rodney Sacks stated the following: "The growth of the energy drink market in the United States has softened from previous quarters."

In spite of recent results, shares of MNST remain range-bound between $52 and $59 a share. Part of this anomaly is the company's ability to consistently deliver increased earnings and the company's ability to generate consistent cash flow that supports its "healthy" share repurchase plan. On April 8th, Monster Beverage Corporation announced that its Board of Directors had authorized a new share repurchase program for the repurchase of up to $200 million of the company's outstanding common stock. There was no availability remaining under the previously authorized $250 million share repurchase program.

I quoted "healthy" in my description of the buyback plan because given the current slowing rate of growth, which helped to grow earnings in Q4 2012; this share repurchase plan may end or not be executed if the trend for sales continues. Over the last year, Monster's cash and investment balances have dropped from $793.81 million to $340.95 million. This extreme drop in cash of 55% argues that the company won't be able to continue retiring shares at the pace it did in the last year; it simply isn't a smart way for the company to spend capital in a cash intensive business.

Margins

Let's turn our attention now to the margin side of the equation. Monster is forced to spend a sizable amount of capital in an ever-competitive energy drink category. On top of this realization, the company is also in cross-channel competition with the ever-growing coffee flavored drinks category that continues to gain market share YOY. Overall coffee consumption jumped by five percentage points this year already according to the NCA National Coffee Drinking Trends (NCDT) market research study. With this increase, 83% of the U.S. adult population now drinks coffee. At the same time, daily consumption remained strong and steady at 63%, while those who drink coffee at least once per week was up slightly to 75%.

Moreover, the combination of higher promotional expenses and lower per case pricing, contributed directly to Monster's gross margin dropping from 52.3% last year to 51.7% which was reported in Q4 2012. Relatively speaking, Coca-Cola's (KO) gross margin of 59.60%, and Dr. Pepper Snapple's (DPS) margin of 59.23% both soundly beat Monster. Even PepsiCo's (PEP) gross margin of 51.62% is very close although the company has a product mix of foods and beverages within its business model. Below is a table outlining the previous four reporting quarterly gross margin results for MNST. It is important to note, that the company's initial inventory build into Japan occurred during Q1 2012 and margins have been under pressure ever since:

Q1 2012

Q2 2012

Q3 2012

Q4 2012

53.1%

51.8%

50.5%

51.7%

YOY Change

+1%

-1%

-1.2%

-.6%

Although the recent trend in gross margin contraction seems to have damaged profitability which can be easily identified by the slowed rate of EPS growth, the company should begin to cycle through lower commodity costs. Additionally, the current quarter should show a benefit from the strong euro performance against the USD. Lastly, improved operations and contributions from its Australian partners should add to margins in the coming quarters. However, we can't be too certain as A&P expenditures may offset these lowered commodity costs benefits.

Competition Increasing

As noted earlier, we can't discount Monster's need to continue with a high rate of promotional spending in light of increased competition in the category, most recently by PepsiCo and its Mountain Dew Kickstart drinks that were launched this February. Also, XYIENCE's new non-carbonated Xenergy + beverages rolled out to select retailers March 1, 2013. Xenergy + Hydration, Xenergy + Tea and Xenergy + Lemonade are zero-calorie, sugar-free and vitamin fortified drinks that are made with all natural flavors and colors. Xenergy + Hydration contains no caffeine; Tea and Lemonade offer 10 mg of caffeine per ounce. The new beverages debut first in the Western and Midwestern states; other states will follow. Average retail pricing for the Xenergy + is $2.29-$2.79 which places value on the side of Monster Energy drinks.

Naturally, we can't leave out Red Bull's most recent product development and launch into the energy drink category. The Red Bull Editions flew off the shelves during a six-week retail test last November and December, and confirmed the company's projections that with perfect in-store execution, the Red Bull Editions have the power to grow the entire energy drink category by more than 5%. All three flavors quickly rose to be top-selling beverages during that period, even ranking in the top 25 of energy drinks, according to Retailer Internal Scan Data for the eight weeks through December 2012. Seventy percent of repeat purchasers mentioned taste as a key driver for them, according to a 2012 Attitude Measurement Custom Survey.

Here is the most important take away from the competitive landscape that will continue to advance for the foreseeable future; it's about slotting. Slotting fees go up as competition comes on line. If you aren't willing to support those slotting fees, in some instances, the retailer will go with a competitor's product. Also of relative importance are orders. Convenience stores are looking to grow dollar/slot sales and there is no better place to do this than the energy drink category. As the energy drink category grows, so does dedicated shelf space which one can assume leads to an initial build in new orders for new products. Monster Beverage could find itself in a battle, not only against its past performance, but against the desire for convenience store operators to deliver new products to customers in the energy drink category.

So what exactly are those convenience store operators doing lately? Let's take a look at 7 Eleven Inc. as one of the biggest participants in the convenience store channel. 7-Eleven Inc. gave away free bottles of MiO Energy Black Cherry Liquid Water Enhancer, a fitting promotion for the largest retailer of single-serve bottled water. The free 1.08-ounce full-sized bottle of MiO Energy Black Cherry (regularly priced at $3.99) was available at participating 7-Eleven stores from midnight to 11:59 p.m. Tuesday, April 23, with no purchase required to customers 18 and older.

The International Company Perspective

If we look at Monster's YOY expansion results, we get a better understanding of what we may be able to expect from the firm in the current quarter. It is very important to consider that the company has grown by leaps and bounds since Q1 of 2012. However, with this in mind, we have to consider the company will also need to match those initial pipelines from Q1 of 2012 at the very least. It is hard to find another pipeline that would equate to the inventory build via the Japanese expansion efforts last year during the same period. Most recently, UBS spoke out in favor of Monster Beverage citing that sales could come in better than expected due to foreign markets. UBS wrote that sales in foreign countries could enable the company to report significantly stronger than expected results over the long-term.

ANALYST OPINION: "The total market outside the U.S. for energy drinks is $20B, the firm estimated. By the end of 2016, international sales will lift Monster's earnings per share by $1, UBS predicted. Monster only recently launched operations in the second and third largest markets for energy drinks, Japan and Brazil, UBS explained. The firm raised its 2016 earnings per share estimate for Monster to $4.47 from $4.12 to more accurately reflect Monster's earnings per share opportunity and maintained a Buy rating on the share".

It's also important to note that on February 28, 2013, UBS lowered this year's volume estimate to +15% from 18%, but see trends improving sequentially through 1Q into the back half of the year. The firm sees flat pricing but 70bp of margin expansion as international turns profitable. The firm trimmed 2013 EPS from $2.43 to $2.35 and 2014 from $3.02 to $2.87. Here is a link for the current ratings and analysts price targets on MNST.

On March 8, 2013, Nielsen had the following commentary on the energy drink category: Nielsen convenience store data showed that the energy drink category was up 6% for the four weeks ended 2/16, while Monster Beverage outpaced the group at +7.4% and resumed its share gains.

Monster Beverage Corp. has noted the changes in operational activity for which it hopes to achieve greater profitability in key markets around the world. During Q3 of 2012, the European and African market operations overall began operating profitably, particularly South Africa where the firm had made good strides in increasing distribution levels and sales. The Central and Eastern European region is still incurring operating losses, although Monster is beginning to see the benefits from certain strategic changes that were recently employed.

Continued product development and innovation (15-ounce energy shakes called Muscle Monster that will contain 25 grams of protein per can) should help Monster Beverage diversify its product line and segment itself along new channels. Monster Java is a perfect example of this segmentation of its business, as it will be adding Kona Cappuccino to this particular product line. Additionally, one major opportunity energy drink manufacturers in the U.S. market have not yet addressed is offering re-sealable PET or aluminum packages. New research from beveragepulse.com shows that 65% of energy drink users said they would buy energy drinks in plastic bottles.

Monster Beverage Corp. has a great business model and finds itself fighting an uphill battle against consumer sentiment and increased levels of competition. With that said, operational improvement and a steadily improving macro-economic picture could re-accelerate growth in the coming quarters. We look forward to viewing Monster's upcoming Q1 2013 earnings. After underperforming in 2012, and with a more favorable P/E multiple than its peer group, Q1 2013 has to be the company's turning point or the company will not only have to contend with consumer sentiment deterioration, but with investor sentiment deterioration.

Source: Monster Beverage Q1 2013 Earnings Preview