By Barry Schwartz
Lock the prison door and keep your hands away from the bars. Dr. Pepper Snapple (DPS) is a stock cannibal that you should buy and put away for good. A stock cannibal is a company that is buying back a significant amount of stock over time. (For more on stock cannibals, please see one of my previous articles.) Some people might be thinking, "A soft drink company as one of your top investments? How lame is that?"
Admittedly, Dr. Pepper Snapple is in a growth-challenged business. With over 80% of its sales coming from carbonated soft drinks, the company's most recent quarterly release was anything but exciting. Volume growth was non-existent and its meager earnings growth was helped by accounting changes. With only limited revenue growth outside North America, Dr. Pepper Snapple isn't growing fast anytime soon, if at all. The company -- which has a long-term growth sales target of 3%-5% a year -- clearly has to go back to the drawing board. With all the negatives out of the way, I present my thesis.
Dr. Pepper Snapple is cash flow machine of the highest order that has now recognized its true calling is returning cash to shareholders in a big bad way. The company is on track to generate close to $700 million, or $3.50 per share, this year in discretionary free cash flow. This amounts to a 7.5% free cash flow yield. With a current dividend of $1.52 a share, the company plans to repurchase close to $400 million of share this year. Management recently noted that its capital expenditure requirements should fall going forward. Its balance sheet is in good shape, with a very manageable debt load given its cash flow.
With a modest goal of 1% sales growth per year and 2% earnings growth, Dr. Pepper Snapple should be able to increase its dividend 5%-10% a year and repurchase at least $350 million of its shares annually. Given its discount valuation to Coca-Cola (KO) and PepsiCo (PEP) as well as its high ROE, a continued share buyback program is the smartest use of capital. Upside surprises may come from a much-needed sales push outside North America as well as a faster adoption of its "Ten" franchise of low-calorie sodas.
One more thing: Dr. Pepper Snapple is a very buyable company. It has no major shareholders and no activist investors shaking up its board (at least not yet). It would be an immediately accretive target for either Coca-Cola or PepsiCo since it trades at a 25% discount on P/E vs. the big boys. Synergies could be significant as well. Why have two delivery trucks going to the same store when you can just have one? With a market capitalization of only 5% of Coca-Cola, Dr. Pepper would be a tasty little fizzy bite.
While some investors may see a slow-growth, boring business, I see a wonderful work of investment art that needs to be locked up right away.
Disclosure: Clients of Baskin Financial own shares of DPS.