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The growing population and rising disposable income globally are the key factors for beverage industry growth. The companies in this industry are looking for higher market share, which has compelled them to develop new strategies such as brand advertising, product innovation and store expansion. The biggest concern for the industry is growing health consciousness, which has resulted in consumers shifting away from carbonated soft drinks. In this article, we analyze three key players in the beverage industry that are jumping on expansion opportunities and are enhancing their product offerings to drive their earnings.

Snack business growth

PepsiCo's (PEP) Frito lay North America segment reported revenue of $3.3 billion in the second quarter ended June 15, 2013, reflecting growth of 4.3% year over year. With 38.1% market share, the company has a leading position in the North American snacks market, and its market share is increasing by investment in brand advertisement. In July 2013, Frito Lay North America and Activision Publishing, subsidiary of Activision Blizzard, partnered for a summer promotion that offers fans interaction with the Skylander Giants Character on Frito Lay snack packs. The company occupies the most space in retail stores by selling more brands in the segment than any other player and expects its market share to reach 39.1% this year.

The company is planning to launch a new brand of premium bottled water called 'Om' next year. It currently offers bottled water under its Aquafina brand, but does not offer any brand under the premium category. The new launch will help the company to compete with Coca-Cola's premium water brand Smartwater. This strategic move will help PepsiCo offset the slowdown in the North American beverage business, which is facing headwinds in carbonated soft drink, or CSD, consumption due to growing health consciousness among consumers. But, the consumption of bottled water in the U.S. is showing continuous growth. Bottled water sales increased 6.7% year over year to $11.8 billion in 2012.

The per capita consumption of bottled water was up 5.3% year over year with Americans drinking on average 30.8 gallons of bottled water last year. We expect the growth in bottled water to continue with increasing consumer health consciousness and convenience driving more consumers towards bottled water. The successful launch of this premium water brand will improve PepsiCo's margins in the bottled water business, as consumers pay more for premium water.

PepsiCo's trailing 12-month PE is 18.78, and its forward PE ratio is 16.88. The drop in forward PE implies that the company's earnings are expected to grow in the future. The company is expecting 7% growth in EPS to reach $4.40 this year compared to $4.10 last year.

Also, read our detailed coverage: Coca-Cola And PepsiCo: Despite Recent Concerns, Investing In These Beverage Stocks Smells Like Money

Agreement to expand product offering

On July 22, Dr Pepper Snapple Group (DPS) entered a seven-year agreement with The Wendy's (WEN) to expand the availability of its soft drink brand "Dr Pepper" and "Diet Dr Pepper" in Wendy's restaurants. Wendy's has served Dr Pepper since it opened in 1969. Currently, it offers Dr Pepper in 4,600 restaurants and Diet Dr Pepper is offered in several hundred locations. With this agreement, it will add Dr Pepper and Diet Dr Pepper in more than 5,800 Wendy's restaurants in the U.S. The agreement provides opportunity for Dr Pepper Snapple Group to offer its two biggest brands to more consumers. The increase in customer base by enhancing offerings in more restaurants will add to its revenue. Wendy's is one of the company's biggest food service customers,

Scott Johnson, Senior Vice President of fountain foodservice sales for DPS, said "the agreement provides a great opportunity to put the company's biggest brand in front of more consumers".

We suggest a buy rating on Wendy's. Please read: Beyond Wendy's Week Of Action

Dr Pepper is currently facing challenges in carbonated soft drinks due to growing health consciousness among consumers. This has lowered its topline growth guidance to 2% this year, compared to its previous guidance of 3%. However, the earnings are expected to grow with LIFO inventory benefit, which is attributable because of the low cost of apples. Due to a high-yielding apple crop this year, the prices are low. The company uses apples as raw material for its beverages and maintains the inventory on LIFO method, which will result in a benefit of $30 million.

Figures in US $ billion

2012

2013 (expected on 2012 basis)

Sales

5.99

6.11

EBITDA margin

20.00%

20.00%

EBITDA

1.2

1.22 + .030 = 1.25

Assuming the same EBITDA margin of 2012, and adding the LIFO inventory benefit, we estimate EBITDA of around $1.25 billion in 2013. Moving ahead, the company's trailing 12-month EV/EBITDA is 8.95 compared to its peer PepsiCo 's 11.57. The EV/EBITDA is a ratio of the company's enterprise value to its earnings before interest, taxes, depreciation and amortization. This ratio determines the value of the company including its debt and other liabilities with actual cash earnings. The lower EV/EBITDA indicates that the stock is undervalued. The stock is also attractive with a forward dividend yield of 3.40% compared with the industry's 2.6% dividend yield.

New store openings to drive revenue

Starbucks' (SBUX) China Asia Pacific, or CAP, segment reported revenue of $233.7 million in its third quarter ended June 2013, with 29% year-over-year growth. The increase was due to incremental revenue contribution from 523 net new store openings in the last 12 months and 9% increase in comparable-store sales. China represents the company's priority for international expansion in this segment, due to its massive potential market as an average consumer in China drank two cups of coffee per year in 2012, whereas globally the average is 134 cups. The company targets to open around 600 new stores in fiscal year 2013, and 700 new stores in fiscal year 2014. We expect that new store openings will further drive the revenue of this segment due to the low number of coffee drinkers in the country currently.

The company acquired La Boulange Bakery last year to expand its food offering of pastries and other baked goods to its customers. As of the third quarter, La Boulange offerings were available in 1076 stores. The company plans for expansion of La Boulange bakery items to 3500 U.S. stores by the end of this year and in all the U.S. stores by next year. La Boulange food business will be a second driver of same-store sales, after beverages, driving additional traffic to stores. One out of every three Starbucks customers purchase a food item, and on average the customer spends around $1.40 on food. The spending on food is expected to rise 0.6% annually, reflecting the benefit of expanding its food offering to more stores. An increasing proportion of consumers ordering food items along with coffee provides an opportunity for Starbucks to boost its sales. The food currently contributes around 19% in total revenue, and expansion is targeted to increase the total revenue contributed from food.

Starbucks expects revenue to grow around 10%-13% year over year in the fourth quarter and also for fiscal year 2014. The unit expansion and La Boulange food product offering are drivers for the company's earnings growth. The company's trailing 12-month PE is 33.74, and its forward PE is 26.47. A lower forward PE implies that the company's earnings are expected to grow in the future. Also, its EPS is expected to reach $2.22 this year and $2.65 next year compared with $1.79 last year.

Conclusion

All three companies have long-term growth potential with their planned strategies. Starbucks is accelerating its new store openings and expansion of La Boulange food offerings to drive more traffic to stores. PepsiCo's leading position in the snack business with Frito Lay North America and plan of launching new premium brand bottled water will improve its margin. Dr Pepper Snapple's agreement with Wendy's will enhance the offering of its top two brands in more restaurants, and it is cheap stock with attractive dividend yield. Considering the above fundamental factors, we are optimistic on these stocks, as these factors should drive the earnings of these companies.

Source: 3 Sweet Spots From The Beverage Industry