Dr. Pepper Snapple: Tapping into Record Growth

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 |  Includes: CSG, DPS, MCD
by: Paul Price
Dr. Pepper Snapple (NYSE:DPS) is a vertically integrated brand owner, bottler, and distributor of nonalcoholic beverages in North America. In 2008, the firm generated about 89% of its sales from the Unites States with the other 11% coming from Canada, Mexico and the Caribbean. The company's leading carbonated brands include Dr Pepper, 7UP, Sunkist, Squirt, YooHoo, Schweppes and A&W. Its noncarbonated brands include Snapple, Mott's and Hawaiian Punch. DPS was established in 2008 following the spinoff of Cadbury Schweppes Americas beverages from Cadbury Schweppes PLC (CSG). Currently configured shares began trading on the NYSE on May 7, 2008.
EPS exceeded estimates in the September quarter at $0.54 this year versus 2008’s $0.45. Zack’s now sees full year earnings of $1.96 for 2009 and $2.21 for 2010. At today’s price of $28 that puts the multiple at < 14.3x this year’s and about 12.7x next year’s expectations.
Management recently initiated quarterly dividend payments of $0.15 /share – a current yield of 2.14%. The first ex-dividend date is December 17th with a January 8th payment date. They also announced a $200 million share buyback authorization.
Here are the pro forma per share numbers as reported by Value Line:
Year
Sales
Cash/Flow
EPS
B/V
2007
22.67
2.19
1.79
19.81
2008
22.51
2.30
1.85
10.28
2009*
21.80
2.40
1.96
11.94
* 2009 figures include Q4 estimates
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McDonalds (NYSE:MCD) plans to add both regular and diet Dr. Pepper as a fountain drink option in about 14,000 of its U.S. fast food outlets. DPS also plans on expanding its cold drink vending machine numbers by over 35,000 as part of a five-year plan.
Now that DPS is showing renewed growth I think it’s likely that these shares can trade for at least 14 times forward earnings. At that multiple, I project a 12-month target price of $30.94 /share – about 10.5% about the current quote. Add in the 2.14% yield and a better than 12.5% total return looks to be a conservative goal.
Is that reasonable? DPS shares touched a recent high of $30.65 and hit a peak price of $28 shortly after their mid-year 2008 IPO. Fundamentals look better now than they did back then.
Since the upside is decent, but not spectacular, I’m using the sales of both covered calls and naked puts to augment the potential returns between now and next May 21st. Here’s my preferred play…
Cash Outlay
Cash Inflow
Buy 1000 DPS @ $28.00 /share
$28,000
Sell 10 May $30 Calls @ $1.65 /share
$1,650
Sell 10 May $25 Puts @ $1.35 /share
$1,350
Net Cash Out-of-Pocket
$25,000
Click to enlarge
If DPS shares climb to at least $30 (+ 7.2%) by May 21, 2010:
  • The $30 calls will be exercised.
  • You will sell your shares for $30,000.
  • The $25 puts will expire worthless.
  • You will have collected $300 in dividends.
  • You will have no further option obligations.
  • You will end up with no shares and $30,300 in cash.
That would be a best-case scenario total return of $5,300 / $25,000 = 21.2% achieved in just 5.3 months on shares that only needed to rise by 7.2% or more.
If DPS shares close unchanged (from today) at $28 on May 21, 2010:
  • The $30 calls will expire worthless.
  • The $25 puts will expire worthless.
  • You will have collected $300 in dividends.
  • You will have no further option obligations.
  • You will end up with 1000 DPS shares (worth $28,000) and $300 in cash.
That would be a static return profit of $3,300 / $25,000 = 13.2% achieved in 5.3 months on shares that did not go up.
What’s the downside?
If DPS shares close < $25 on May 21, 2010:
  • The $30 calls will expire worthless.
  • The $25 puts will be exercised.
  • You will be forced to buy an additional 1000 shares.
  • You will need to lay out another $25,000 in cash.
  • You will have collected $300 in dividends.
  • You will have no further option obligations.
  • You will end up with 2000 DPS shares and $300 in cash.
Break-even would be figured as follows:
On the original 1000 shares, it’s their $28 purchase price less the $1.65 /share call premium = $26.35 /share.
On the ‘put’ shares it’s the $25 strike price less the $1.35 /share put premium
= $23.65 /share.
Your overall break-even would be $26.35 + $23.65 / 2 = $25 share (ignoring dividends).
You are protected against loss on any drop less than $3 /share from the original $28 price at trade initiation. You have a built-in 10.7% margin of safety.
Disclosure: Author is short DPS puts.