SodaStream International Ltd. (SODA) will report its Q2 2013 results on July 31, 2013. These results will be highly scrutinized by the investment community as shares have come under severe pressure in the last several weeks and are now resting below the 90 day moving average. In spite of the recent share price decline, the mean price target offered by the 12 participating analysts is roughly $78 a share, representing a potential price appreciation of 40% from the June 18th closing price.
In the most recently reported quarter, SodaStream earned $.57 a share on $117.6 million in revenues, beating analysts' expectations for both key metrics. In spite of these metric outperformances, shares of SODA fell on the day for the following reasons:
- Sales were flat in CEMA region
- Sales were down by 1% YOY in Asia-Pacific region
- Shipments were halted during the quarter to Japan due to CO2 certification issues
- Upcoming tough comps in Q2 were being weighed by investors
- Machine growth YOY was not as strong as anticipated in spite of strong consumable sales
Sales for consumables during Q1 2013 continued to outperform for both CO2 and flavored syrups. Flavored syrups rose 34% and CO2 rose 30% YOY during the quarter. Strong consumable sales were the likely achievement of operational improvements and marketing as the company has dedicated itself to increasing the frequency of usage for its soda maker systems. During Q1, several retailers added flavor skus to their existing product line as SodaStream continues to add new flavors YOY. To compliment syrup flavor additions, several retailers also commenced the CO2 exchange program. Both Kohl's (KSS) and Best Buy (BBY) have initiated the CO2 exchange program in the first half of the year. Investors should note the importance of the CO2 exchange network and how it creates the biggest obstacle for new entrants/competitors in the product category. In addition to these noted retailers' commencement of the CO2 exchange program, Staples UK, Sainsbury UK, Kroger (KR), Office Depot (ODP) have all commenced the CO2 exchange program.
Moreover, with regard to the CO2 exchange program, SodaStream continues to build upon its product variation, adding to choices, convenience and the value proposition. During Q2 2013, SodaStream has begun adding to its existing 60L CO2 exchange with more stores now performing both the 60L and 130L CO2 exchange. The value proposition offered by way of the 130L exchange further reduces the cost per liter and very likely will increase usage rates and retention rates year-over-year. During the 2nd quarter, SodaStream rolled out the 130L CO2 exchange at Bed Bath and Beyond (BBBY) Office Depot and select Hyvee stores.
Now let's take a closer look at analysts' expectations for Q2 2013 results:
- Earnings: $.57 a share
- Revenues up 26% YOY to $129.7 million
- Gross margins: 54%
- Machine unit sales growth 18% YOY
- Consumables unit sales growth 24% YOY
A Challenging Quarter For GM%
Q2 2013 represented the most challenging quarter for SodaStream since coming public in 2010. The most challenging aspect of its operations as it pertains to achieving its stated goals and investors' goals was to manage the company's growth strategy in tandem with demand for its products outstripping its manufacturing capacity. The company has taken steps to address the manufacturing issue by partnering with third-party manufactures, including the most recent partnership with Cott Beverge Inc. (COT). Investors can easily see that the deal has already produced hundreds of thousands of packaged syrups in North America by visiting their local retail outlet and viewing the "Made In USA" label on a flavored syrup bottle where it had once been labeled "Made in Israel."
The significance of the Cott/SodaStream partnership is two-fold. First and foremost, by producing syrups in a major consumer market such as the United States, local manufacturing and packaging insures prompt delivery of product and reduces out-of-stock times. Secondly, readily stocked shelves due to prompt delivery serve to increase sales of available SodaStream flavored syrups. The argument has come forth that third party manufacturing also serves to depress margin growth performance. While we tend to agree with this point of analysis, we believe the gross margin growth mitigation is more than offset with increasing sales, which feed to bottom line outperformance. In Q1 2013, gross margins did contract to 54.5% from 55% in the year ago period without the benefit of local manufacturing in the U.S., but with alternate third-party manufacturing globally. SodaStream's initial gross margin guidance for FY13 is currently 54%. While the company has managed to exceed this guidance in the 1st quarter of the year, the commencement of the Cott Beverge Inc. partnership during Q2 may prove to erode between 50bps and 100bps of gross margin during Q2 and for the remaining portions of the fiscal year.
In addition to third-party manufacturing dynamics, which will likely persist well into 2014 and as SodaStream completes its build out of a new 1million sq. ft. manufacturing facility in Israel, gross margins will serve to come under pressure for a few other reasons. As the company continues to grow and expand into new markets as well as existing markets, we have to recognize the costs associated with these operations. Most new markets do not become profitable for 12-18 months, even the strongest consumer markets. With this in mind, we expect the company to carefully expand into new markets in order to achieve the stated goals for the year and the company's annual guidance. If we look at the expansionary achievements in North America during Q2 2013 we note that the company added over 1,500 doors during the quarter . Associated with this expansion effort are high costs, which include procurement of goods, manufacturing, shipping, advertising and promoting, et cetera.
Our last point of analysis regarding gross margins during the quarter is related to the price reduction associated with the Source soda maker. The Source originally debut for sale in North America with a price point of $129.99 at most participating retailers. In May, the company lowered the price point to $99 after stating it would do so only when it was able to take some of the associated manufacturing costs out of the price.
It is important to analyze near- to mid-term gross margin results within their most appropriate context. Based on current manufacturing capabilities and needs, gross margins will remain pressured, but still within a reasonable measure of related profit performance goals. The longer-term outlook for gross margins can be accessed through SodaStream's Investor Day Presentation.
SodaStream currently has 22 active manufacturing and/or packaging plant locations around the world. The company is looking to add 4 new facilities in the coming quarters. In key markets such as South America and Japan, where the company is growing, localized production will serve to supply these markets more proficiently and more profitably. As noted earlier, SodaStream's biggest facility, which will likely be fully operational by the end of 2014, will serve to expand gross margins through 2014 and well beyond. SodaStream has indicated that it can possibly achieve gross margins of 56% by 2016
During 2012, SodaStream grew its retail distribution network by roughly 50 percent. With this achievement behind it, the company has dedicated itself to 2 core objectives this year: Dollars/door growth and additional door growth. Within existing markets, as SodaStream matures, the number of doors the company is able to expand into becomes fewer and fewer, however, investors should not discount that the company has new channels of distribution it has only begun to explore such as drug store, liquor store and grocery store retailers. In 2012, SodaStream began exploring the drug store and grocery store retailers with point of distribution at Wegmans, Haggen, Rice Epicurem, Lewis Drugs, Giant Foods and London Drug Store in Canada, to name just a few.
Already in 2013, SodaStream has expanded further into the grocery store channel with HEB. HEB Grocery Company, LP is a privately held San Antonio-based supermarket chain with more than 315 stores throughout the U.S. state of Texas and northern Mexico. The company also operates Central Market, an upscale organic and fine foods retailer. We would expect SodaStream to continue with its grocery store expansion efforts in North America in the coming quarters. In New York City, where SodaStream has a vast user base and a dense distribution network, the company has indicated it would seek to establish a distribution partnership with Duane Reade to commence in the 4th quarter of 2013. Duane Reade is a subsidiary of Walgreen Corp. (WAG) and boasts over 250 stores in New York City. Should this stated objective become an achievement, sales could meaningfully grow YOY in this general region, which already boasts strong sales
Elsewhere in North America, SodaStream has expanded into 200 Alco (ALCS), 400 Kroger hypermarket stores and has been featured on end-cap displays in a similar fashion to Wal-Mart (WMT) and Target (TGT) over the last year. Kroger has begun testing the CO2 exchange process in stores. Office Depot is now offering SodaStream products in some 500 locations with 25 flavored syrups, bottles, spare CO2 cylinders, 60 and 130 liter CO2 exchanges, the Jet soda maker and the Source soda maker kits. Much like Staples (SPLS) and Kroger, Office Depot is featuring SodaStream on an end-cap display.
On another note, with SodaStream's expansion into Sainsbury grocery stores in the United Kingdom, this effort represents the first time SodaStream products will be positioned in the ready-to-drink (RTD) aisle with competitors such as Coca-Cola (KO) and Pepsico (PEP). Moreover, as it pertains to the region of Poland, SodaStream has plans to continue to expand into more hypermarket retailers in the second half of the year.
SodaStream Professional SO
SodaStream Professional, or SO, as it has been trademarked, it the commercial division of SodaStream, which specializes in away from home, hospitality water on-demand machines. The division was born out of the acquisition of CEM Industries., an Italian corporation which manufactured and distributed like equipment for the hospitality industry. The acquisition took place in late 2011 and has since been in development as a branch of SodaStream. In 2012, SO began marketing its product line around the world and to date has roughly 350 restaurants using the SO products in Greece, Italy, Germany, Sweden, Russia and France. SodaStream has recently brought the product line to the United States as it plans to continue its expansion of the SO brand product line.
The commercialization of SodaStream's technology is apparent. Many restaurants around the world currently use SodaStream's simple soda makers because they are eco-friendly, save money and storage space in an otherwise overcrowded kitchen space. One such North American chain of beverage shops that recently began using SodaStream is Davids Teas. Davids Teas has nearly 100 locations throughout Canada and now 15 locations in New York City and 2 locations in California. The company recently introduced a new product to its menu called the Tea Pop. The Tea Pop is none other than the creating of sparkling tea in a wide variety of flavors made with a SodaStream machine and powered by SodaStream's CO2 cylinders. Most Davids Teas shops are currently outfitted with a SodaStream and a stockpile of CO2. Given the recent push into North America by SO, we would expect Davids Teas to begin deploying the commercial grade appliances in the near term.
As indicated earlier, SodaStream has over 350 restaurants currently using its SO products. The company's stated goal for 2013 is to end the year with 1,500 points of use around the world.
Investors and consumers alike are looking forward to new products from SodaStream. In the current quarter, the company is expected to launch V8 Splash and V8 Fusion flavors to go along with an ever-increasing flavored syrup product line. During the 2nd quarter, the company launched new and improved cola flavors alongside Diet Cherry Cola and Diet Grape in the United States. In the United Kingdom, oddly enough, Dr. Pete launched in the region. In the first half of 2013, SodaStream has already launched 8 new flavors in the United Kingdom: Highland Fizz; Dr Pete; Diet Dr. Pete; Bitter Lemon; Ginger Beer; Diet Ginger Beer; Elderflower; and Diet Pink Grapefruit. Most retailers in the U.K. are rapidly adopting these new flavors.
During the fourth quarter, SodaStream is expected to launch both Eboost and Ocean Spray flavored syrups in conjunction with SodaCaps in North America. SodaCaps are currently being rolled out in specific markets including Israel, France, Germany, The Nordics, Russia and the United Kingdom. If we look at flavor syrup expansion YOY, what we have to recognize is the sheer number of meaningful skus being added this year vs. last year. In the second half of 2012, SodaStream effectively added 7 recognizable flavor skus to the product line-up. This year, the company has aimed to add roughly 12 flavor skus and a complement of 7-10 varieties of SodaCaps.
Investors seem to overlook bottles as a portion of the consumables sales when evaluating SodaStream. Bottles continue to show strong sell-out rates at retailers across North America and with that in mind, SodaStream continues to innovate its bottle technology. We would look forward to the launch of stainless steel, on-the-go bottles and tear drop bottles in the near future as the company has deployed dishwasher safe, 1 liter carbonating bottles already in the 3rd quarter.
SodaStream has been the target of several rumors over the course of the second quarter. The first rumor speculated upon a potential buy-out of the company by Pepsico. In light of Pepsico's CEO response to the rumors, denying any truth to the rumor, coupled with the time that has passed since the rumor originated, we feel it is safe to say that the reporting agency from Israel that published this rumor as fact has been proven inaccurate. Additionally, based on our conversations with management, they are confident in stating that they have not been approached by Pepsico or Goldman Sachs (GS) regarding a tender offer for the company.
The most recent rumor regarding SodaStream was articulated and published by the NY Post and claimed SodaStream was shopping for a buyer, however, the company could not find one. Through careful dissection of the reporting agency's article, we conclude that the article bore no merit and was replete with misunderstandings and misrepresentations.
On July 9th, the NY Post released an article detailing their personal belief that SodaStream has been shopping itself over the last three months. Mind you they name no sources within the article and insinuate the opinion of an unnamed analyst. This is not the typical reporting methodology of well-respected media publications as most reporting agencies find themselves validated by citing and naming sources for their quoted materials in publication. For the sake of this report, let us now dissect the NY Post article. Below is a paragraph from the article:
- While CEO Daniel Birnbaum has said he aims to shake up the multibillion-dollar market for carbonated drinks, behind the scenes the maker of do-it-yourself soda machines has been seeking a buyer for at least three months, sources said.
Notice that while the reporter alludes to a source while not naming the source, he doesn't even go so far as to say the usually acceptable phrase, "sources close to the company." This is a very important omission to the story as most reporters understand the fine line between stating "sources said" and "sources close to the company said." Now let us move on to the next point of analyzing the article.
SodaStream has a great deal of moving parts in its respective operation and as such, there remain a great deal of possibilities each and every quarter. Some of the possible announcements that investors may witness on the upcoming conference call could be the commencement of sales to India with the naming of key retailers in the region. We already have the knowledge of the market manager in the region. Doorva Bahuguna took her Regional Market Manager position in February of 2013, offering her the time to staff her team, market the SodaStream name and product as well as sign up key retailers to begin selling SodaStream products . Our most recent research indicates that Ms. Bahuguna is also now looking for a finance manager for the Indian market, indicating that there are indeed deals being negotiated and/or deals that have been closed with retailers. In addition to this possibility and regarding regional expansion, we also expect SodaStream to soon begin selling products in both Argentina and Malaysia. Given the strength of the consumer in these two regions and their close proximity to current distribution networks selling SodaStream products, we anticipate these markets coming into the fold in the near future.
SodaStream has been having noticeable issues with its current distributor in Italy over the last three quarters, which may culminate in the firm acquiring the distribution rights in the region altogether. Given the size of the distributor and the sales produced out of this region, we nominalize the purchase to be 3-4.5 million euro ($3.9-$5.9 million). It is very possible that any excess revenues produced during the second quarter may go toward this acquisition. In keeping with the theme of purchasing distributor rights, we should also note that profit margins from Canada will begin to increase due to the acquisition of the Canadian distribution rights in September of last year.