"While the beverage market in general in North America continues to experience softness, more specifically in CSDs, the energy drink market continues to grow, although the rate of growth still remains in single digits", said Monster Beverage Corporation's (NASDAQ:MNST) CEO Rodney Sacks upon opening up the latest conference call with analysts. Slowing growth has plagued the Energy Drink industry for the last 18 months and it appears it has continued through the back half of FY13.
Unfortunately, Monster Beverage found themselves in the usual position of disappointing investors by missing on both the top and bottom line when considering analysts' expectations for the 3rd quarter. One major factor continuing to weigh on Monster Beverage's results was increased professional service costs. During the third quarter, operating income was negatively affected by increased professional services costs of $6.5 million, net of insurance reimbursements, of which $5.3 million related to regulatory matters and litigation concerning the company's marketing, promotions, ingredients, labeling and safety of its Monster Energy drinks, which the company restates it believes are exceptional in nature. The net effect on earnings per share as it relates to professional services costs, regulatory matters and related litigation is approximately $0.02 per share.
In spite of the higher operating costs, Monster Beverage managed to achieve another record quarter for gross sales. The company achieved record third quarter gross sales, up 8.6% from the third quarter of 2012, to $686.6 million with net sales up 8.9% to $590.4 million. Diluted earnings per share increased 13.1% from $0.47 per share in the third quarter of 2012 to $0.53 per share in the third quarter of 2013. Even though the company had a strong quarter on the top-line, analysts had modeled for revenues to come in at $602.34mm on $.57 earnings per share. So let's look at what hindered the hopeful growth in revenues during the quarter as outlined by Rodney Sacks.
The Cons For Q3 2013
- Less robust growth sales for the energy category as a whole, in our principal market, the United States.
- Less robust growth of the energy category overall in Europe, despite the slower growth Monster was still able to achieve 8.6% growth in dollars in that region in the third quarter, well ahead of the growth of the category overall in that region.
- Sales of Zero Ultra and Ultra Blue energy drinks, although accretive, did result in some cannibalization generally across our existing SKUs.
- Sales were positively affected by the launch of Ultra Blue energy drink as well as sales of the new Muscle Monster line, however, sales of Monster Energy products in glass bottles and the Extra Strength line were lower, as were sales of Worx energy shots.
- Sales in the DSD division in North America were 10.6% higher in the third quarter and contribution margin from the DSD division during that period was up 14.2% over the comparable period last year. Sales in the warehouse division were lower as a result, primarily, of an unsuccessful promotion with a large retailer, including an extensive sampling and in-store demo program. The warehouse division incurred an operating loss of $2.2 million as compared to a small operating profit that was earned by the division in the same period last year.
- According to Nielsen's Scantrack Data, Monster Beverage sales decreased 11.3% in September and its market share decreased 4.8 points to 33.7% over the comparable period last year.
- The weaker yen continued to negatively affect gross sales in U.S. dollars, as well as margins in Japan during the quarter. Sales to Monster Beverage's Japanese distributor in the third quarter of 2013 were lower in dollars than in the comparable quarter last year.
The Pros For Q3 2013
- Monster Beverage achieved record gross sales up 8.6% from the third quarter of 2012, to $686.6 million with net sales up 8.9% to $590.4 million.
- Plans for production in Japan and Korea are proceeding satisfactorily. Test production runs have now taken place in both Korea and Japan. Monster Beverage is on track to commence full commercial production in Japan within the next few months.
- Sales in Chile are progressing well. In Brazil, Ambev, continued to secure increased distribution levels from month-to-month and had a record month in October.
- In the warehouse division, sales of Hubert's Lemonades in glass bottles for the 9 months through September 30, 2013, are significantly above sales in the previous comparable 9-month period.
- Gross profit margins achieved in the third quarter of 2013 were 52.1% versus 50.5% in the comparable quarter in 2012.
- Gross sales in October 2013 were approximately 9.3% higher than in October 2012.
- In October, the company launched a new Monster Ultra Red line extension, and is in the process of launching a new strawberry Muscle Monster energy shake. The company's planning to launch a further line extension of its Muscle Monster line at the beginning of 2014.
So where does Monster Beverage go from here investors may be asking themselves. Well, first and foremost the company needs to continue to address the changes in consumption habits around the world which indicate that the CSD market is showing decreases in volume year-over-year as water and flavored water drinks continue to sharp increases in volume year-over-year. . Consumers are seeking out healthier alternatives to traditional soft drinks, including energy drinks.
Monster Beverage is advancing its product line through adjacent sales channels such as the coffee flavored energy drink category and its Hubert line of products which continue to gain market share. Unfortunately, these lesser focus lines of the company will take much time to achieve the necessary market penetration to overcome the weakening energy drink category which is the core of the Monster Beverage business.
On the operational side of the business, gross margins continue to show improvement year-over year. As Monster Beverage expands its partnerships and local production capabilities, a great deal of shipping and damages costs will be taken out of the equation. These aspects of localized production in regions such as Southern Europe, Japan, Brazil and India will be no small feats of accomplishments and could provide the company with a meaningful buffer to slowing energy drink sales over the next several quarters and as the company attempts to more broadly diversify its product line.
It is important to note that during the most recently completed quarter, Monster Beverage did not repurchase any shares under its current buy-back plan and will continue to advance the conversation concerning the plan with the Board of Directors. Due to the strong gross margins and consistent free cash flow building taking place, an acquisition may come sooner than later. We would consider small distribution partners to be the most likely acquisition targets as this would enable Monster Beverage to run the business in key markets more effectively and profitably.
Monster Beverage is entering a maturation phase in its business which is consistent with a curtailment of its rate of growth in dollar terms. What is not certain is whether or not the company can reinvigorate its product line over the next few quarters as the energy drink market shows no signs of achieving its rate of growth in the past and could possibly slip into negative growth territory in key markets during the next 12-18 months.
Having outpaced its peers' valuation over the last several years and continuously missing the mark regarding growth, earnings and revenue expectations, shares of MNST naturally fell by nearly 5% in the after-hours trading session on November 7th. Since that time, shares are only down roughly 2% and showing signs of strength in just a few short trading sessions.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
