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Monster Beverage Corporation (MNST) develops, markets, sells and distributes alternative beverages, such as non-carbonated ready-to-drink iced teas, lemonades, juice cocktails, single-serve juices and fruit beverages, ready-to-drink dairy and coffee drinks, energy drinks, sports drinks, and single-serve still water (flavored and unflavored) with beverages, including sodas that are considered natural, sparkling juices and flavored sparkling beverages. The company markets its products through retail chains, club stores and specialty stores using an exclusive distributor network.

Energy drinks and shots represent small portion of the non-alcoholic beverage market. This industry has seen tremendous growth since 2008, with total sales in United States close to $13.0 billion presently. This growth has been attained on the backdrop of increased consumer penetration and a drop in sales for traditional carbonated soft drinks, due to health concerns related to cola products. According to Packagedfacts' "Energy Drinks and Shots: U.S. Market Trends," sales for energy drinks and shots are expected grow to $ 21.7 billion, supported by improvements in distribution channels and sustained economic growth. The energy drinks market is currently in its infancy and is expected to grow significantly as energy drink usage increases among its target consumers. Presently, energy drinks account for 78% market share followed by 18% for energy shots and 4% for energy drink mixes.

For the last 12 months, the company reported revenues of $2.2 billion, operating income of $552.0 million and net income of $331.0 million, or $1.98 in earnings per share. The company has realized huge growth in the past nine years with revenue growth of 12.7% and operating income and net income growth of 16.8% annually, capturing a market share of 35%. Figure 1 highlights the year-over-year growth Monster Beverage has realized since 2004.

Click to enlarge images.

Figure 1: Year-Over-Year Growth in Revenues, Operating Income, and Net Income for Monster Energy

Source: Data taken from Morningstar.

Monster Beverage has been able to maintain its operating margins and net margins for the past several years, with the only exception being compression in margins during 2008. This supports the fact that company is not growing revenues by compromising on margins. It competes directly with other energy drink manufacturers such as Red Bull and with big stalwarts like Coca-Cola (KO) and Pepsi (PEP) to gain the shelf space at convenience stores. Increased health concerns among consumers with regard to the usage of carbonated soft drinks have worked in Monster's favor, but recent allegations related to the safety of its products seems to offset the tailwinds it had. Figure 2 compares the operating and net margins for Monster Beverage against Coca-Cola and Pepsi.

Figure 2: Operating Margins for Monster Energy, Coca-Cola, and PepsiCo

Source: Data taken from Morningstar.

Figure 3: Profit Margins for Monster Energy, Coca-Cola, and PepsiCo

Source: Data taken from Morningstar.

As the business has grown over the last several years so have the reinvestment requirements, enabling the company to grow its revenues. Management has been very effective in analyzing industry trends, growth opportunities, and making decisions to reinvest. Figure 4 highlights the relationship that exists between revenue growth and the reinvestment rate (i.e., part of operating income after taxes, which gets invested back into the business).

Figure 4: Revenue Growth and Reinvestment Rate Since 2004

Source: Data taken from Morningstar.

Monster Beverage has created a huge brand in the marketplace and is aggressively marketing its products in order to attract youth and get them to switch from coffee and carbonated soft drinks to energy drinks, turning them into loyal customers of the brand. Additionally, it is expanding internationally with sales growing in Europe, Japan, the Middle East, and Africa, as well as partnering with industry peers to develop a strong distribution network.

Monster Energy's Valuation

The growth story for Monster energy moving forward is international expansion. However, the firm faces strong competition from Red Bull, which already has an established international distribution network. Even though the firm currently enjoys strong brand loyalty, maintaining pricing power at the current margin levels will be a challenge, as reinvestment requirements for expansion of the business starts to grow. Growth in the future for this company is where investors need to realize the risks are, and factor them in their valuation methodologies. From a valuation perspective, value generated by growth can be put into three categories:

1. Growth Rate

The revenue growth rate expected for the next five years is 15.6 %; operating income is expected to grow 16.3% per year for the next five years.

2. Sustainability of Growth

Developing a globally recognized brand and establishing partnerships for scaling up their distribution network provides a strong competitive edge for Monster.

3. Return on capital

Brand loyalty, product mix, and appealing marketing campaign has helped the company earn higher returns on capital invested. Median ROIC for Monster Energy since 2004 is 47.9% against cost of capital of 8%. Returns generated over and above the cost of capital reflect the quality growth generated and value creation for shareholders.

As investors we should know how much we are paying for growth in a business and should be cautious about paying any premium for lower quality growth. Separating value of assets currently in place from the market price helps in determining how much of a price for growth is built in to the stock price. Using a cost of capital of 8% (the U.S. average in the beverage industry), we can see the value of assets in place, value that growth will add, and the price we are paying for growth.

Figure 5: Value of Existing and Growth Assets Taken From Current Market Price

As illustrated in the table above, assuming Monster Beverage will only be able to earn its cost of capital, the price of growth comes at 3.7 times the value growth assets will generate. At the current price level, the market is implying a growth rate of 23% in the operating income for the next five years. This level of implied growth rate seems higher than our expectations of growth in operating income, but Monster's ability to generate returns far higher than its cost of capital add value for shareholders, which needs to be factored in to company's valuation.

The price investors pay for growth is a variable that investors should pay close attention to. Using the median ROIC of Monster Beverage since 2004, we come up with the value of assets currently in place, value added by future growth, the price we are paying for future growth, intrinsic equity and the enterprise value of the business. For growth-oriented investors, the entry price lower than the sum of value of assets and price paid for growth ($62.87) offers growth at a reasonable price.

Figure 6: DCF Valuation of MNST

I plan to write a follow-up article highlighting in detail the inherent business risks for Monster Beverage, quantify the stock price risk with each ±1% growth variation, and the risks reflected in options markets. I will also analyze the relationship that exists between business risk, growth risk, and the options market perceived risk before determining a potential entry point.

Source: Monster Beverage - Quantifying The Price Of Growth