Dr Pepper Snapple Preview: 10 Line-Up's Performance In Focus

| About: Dr Pepper (DPS)

Dr Pepper Snapple Group Inc. (NYSE:DPS) is set to announce its third quarter results on October 23. We expect the company to report modest revenue growth, primarily led by pricing and volume mix gains as total volumes will likely remain under pressure due to the ongoing soda slump in the U.S.

Dr Pepper Snapple relies on carbonated soft drinks (CSDs) for more than 70% of its revenues. As consumers continue to shift towards healthier alternatives due to obesity and diabetes concerns, the company is betting on the nationwide launch of the low-calorie variants of its Core 4 and RC brands to reverse some of that. However, it has been observed that the low-calorie sodas are seeing more pain than the regular ones due to health concerns associated with the consumption of artificial sweeteners. It will therefore be interesting to note the performance of the TEN lineup during the quarter, as the company has been spending heavily behind its launch.

Our $50 price estimate for Dr Pepper Snapple is about 10% above its current market price.

CSD Woes

As consumers continue to shift towards healthier alternatives due to obesity and diabetes concerns, the soda slump in developed markets is getting bad to worse. The situation in the U.S. is a key example of this trend - all channel CSD sales volume in the U.S. declined 1.2% in 2012, slightly worse than the 1% decline in 2011 and the 0.5% decline in 2010. Per capita consumption of CSDs peaked around 1998 at about 54 gallons a year. In 2012, the figure stood at around 44 gallons a year. Growing consumer awareness about the negative health impact of CSDs has been a major reason behind this trend. A research paper recently published in the American Journal of Public Health concluded: "Soft drink consumption is significantly linked to overweight, obesity, and diabetes prevalent worldwide."

Dr Pepper Snapple derives more than 90% of its revenues from North America and ~80% of its sales volume is made up of CSDs. The company therefore faces significant headwinds from the declining CSD consumption in North America, unlike more geographically diverse players such as Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP).

The TEN Lineup

Dr Pepper Snapple's "TEN" offering boasts of just 10 calories per 12 ounce serving with minimal aftertaste of the artificial sweetener. These drinks contain a mix of high fructose corn syrup and aspartame, which reduces both, the amount of calories as well as the aftertaste effect of aspartame. Following the success of Dr Pepper TEN's initial launch, the company started selling TEN variants of its Core 4 (that include 7-Up, A&W, Sunkist and Canada Dry) and RC brands in test markets last year. With the nationwide launch of its TEN lineup this year, the company aims to attract consumers back to the CSD category.

During the second quarter earnings call, the company executives mentioned that response to the new TEN products has been meeting their expectations so far. They also mentioned that the availability of these new products, as measured by all category volume (NYSE:ACV), has increased to 76% from 65% in the first quarter, and they have so far been able to secure incremental shelf space from most of the retailers. Moreover, the company claims that more than half the dollars spent by consumers on these newly launched products have been incremental to the CSD category.

Low-Calorie Squeeze

Beverage Digest, a trade publication, suggests that the consumption of low-calorie or diet sodas is falling faster that the regular CSDs. It noted that while the sales of regular Coke and Pepsi declined by just 1% and 3% in 2012, their low-calorie counterparts fell by more than 3% and 6%, respectively. This is primarily due to health concerns associated with the consumption of aspartame, an artificial sweetener that contains close to zero calories and is almost 200 times sweeter than sugar. Moreover, it can also be attributed to a growing shift in consumer preferences towards natural or organic ingredients in the U.S. The growing trend recently drove Coca-Cola, the largest player in the industry, to launch an ad campaign specifically focused on defending the use of artificial sweeteners in its diet beverages.

Dr Pepper Snapple's new TEN lineup is also expected to face the heat from the industry-wide slump in low-calorie offerings. Despite the new product launch with almost $25 million spent in marketing and promotions so far, low-calorie sales of the company declined by more than 5% this summer. We will therefore be closely watching the performance of the new TEN lineup as its success in attracting consumers back to the CSD category is the key to Dr Pepper Snapple's future earnings growth.

Disclosure: No positions