Seeking Alpha
Long/short equity, research analyst
Profile| Send Message|
( followers)  

Summary

  • SodaStream's elevated results in Q1 2013 prove to be a high hurdle.
  • Gross margins are forecasted to remain under pressure due to pricing and manufacturing capacity constraints.
  • NPD data is limited in scope when depicting sales generated in the United States.

On May 14th SodaStream International LTD. (NASDAQ:SODA) announced its 1st quarter earnings and revenue results which were both ahead of expectations. In recognition of this over achievement, it should not be overlooked by investors that net income dropped dramatically YOY and revenues grew less than 1% in the quarter as expected. SodaStream reported earnings of $.08 a share on revenues of $118.2mm. So let's look a little more deeply into the quarterly results and what lies ahead for the company.

Gross margins have been forecasted to decline by analysts in FY14 as SodaStream continues to witness headwinds in the United States marketplace, and while the company continues to rely on 3rd party manufacturing during its construction of a new facility in Israel proper. Gross margin for the first quarter of 2014 was 52.3% compared to 54.5% for the same period in 2013. The decline was primarily due to unfavorable changes in foreign currency exchange rates and increased share of higher-cost soda makers in the sales mix, which was partially offset by a higher share of CO2 refills in product mix. We would estimate that with a lower priced soda maker mix coming from U.S. sales during the quarter, this means that Europe's more expensive and less profitable soda maker mix impacted sales and gross margins more heavily than in previous quarters. For example, Germany's Crystal soda maker is more expensive than the popular Jet soda maker sold in the U.S. marketplace. In 2014 SodaStream expects gross margin to be similar to 2013 levels of approximately 51 percent.

As I outlined in my "SodaStream Q1 2014 Earnings Preview", SodaStream witnessed a weak quarter in the U.S. sales channels due to inventory overhang at notable retailers. The 40% increase in soda maker kits sold during the prior quarter was far too much and indicated that there would be some residual inventory remaining in the sales channel beyond the quarter. Also, SodaStream had an extremely tough comparison in Q1 to measure up to on a YOY basis as the company lapped the launch of the Source soda maker in the U.S. mass market retail channel. In Q1 of 2013, SodaStream witnessed unit gains of 78% for soda makers and over 100% for flavors and gas refills, which proved to be a daunting sales comparison. Very simply put, there was no way they could match these numbers on a YOY basis and especially without introducing a new soda maker in the quarter. When recognizing these finer points of business and retail operations, it should be expected that sales would be lower this year versus the same period a year ago.

In the U.S., soda maker units decreased 69% to 80,000 and flavor units declined 20% to 2.7 million while gas refill units increased 27% to a record 1.4 million. Sell out is a better indication of consumer demand and was more encouraging during the quarter. According to NPD, soda maker sell out was down 19% and flavor sell out was down 6% while gas refills increased 47%. As with sell in, these sell out figures also suffer in comparison to a strong Q1 prior year due to the Wal-Mart (NYSE:WMT) end cap program. In addition, NPD does not include SodaStream's largest and strongest account in the United States, Bed Bath and Beyond (NASDAQ:BBBY); so investors should take this factor into consideration. NPD data is roughly 75% Wal-Mart related. This means that the NPD data covers at least 3,000 WMT stores and another 1,000 or so stores in the total NPD data mix. SodaStream has over 17,000 retail doors in the United States. Remember that last sentence there, because this is what is likely going to surprise many investors in the quarters to come. Think back to the 3rd quarter of 2013 where SodaStream had only an 8% increase in total flavor sales during the quarter, and then in the next quarter, there was a dramatic increase in flavor sales beyond 30% year-over-year growth.

While U.S. sales continued to weigh heavily on SodaStream's results during the 1st quarter, the rest of SodaStream's distribution network around the globe faired quite well. In Western Europe, revenue increased 17% on top of the 17% increase in the year-ago period. This performance was driven by strong gains in several markets led by Germany.

Asia Pacific revenue was up 28% compared to last year, driven primarily by another strong performance in Australia, which is another mature market for SodaStream and continues to yield strong growth year-over-year. Selling of soda makers, gas refills and flavors were all up well into the double-digits driven by strong execution at retail and against the consumer. SodaStream is expanding its product assortment presently in Australia to include several North American flavors and the company just launched SodaCaps in the region at Myers department store. Last year, SodaStream launched Dr. Pete in Australia with a great deal of success.

In 2013, SodaStream acquired the distribution rights from its distributor in Japan. It is important to note that much of the Asia-Pacific revenue increase during the 1st quarter of 2014 had little to do with Japan. In fact, in order to ensure a smooth changeover from the distributor partner to SodaStream, the company held back approximately $4 million of soda maker and flavor shipments to the former distributor during the 1st quarter, but continued to supply them with gas refills to meet demand from the base of active users.

The CEMEA region's revenue increased 34% from last year, which was ahead of SodaStream's plans. Following a challenging year for SodaStream's Czech distributor due to difficult macroeconomic conditions, the consumer environment has stabilized and is beginning to show signs of improvement. Sell out of soda makers has accelerated over the past few months and inventory levels are now more aligned with demand. Continued growth in the Israeli business also contributed to the region's outperformance in the quarter.

On the 1st quarter conference call, SodaStream announced the departure of Gerard Meyer, Regional U.S. Manager. In my International Home & Houseweares Show report to clients, I outlined some of SodaStream's Q4 2013 issues related to the U.S. marketplace and how they were being handled by Gerard Meyer. It is apparent with the recent appointment of Scott Guthrie, Regional General Manager of the Americas, that Mr. Meyer's decision to leave the company encompassed some of the issues related to recent U.S. sales performance and the implementation of new leadership within the region.

Scott Guthrie Talks Marketing in the United States

I had the opportunity to meet and discuss all things SodaStream with Mr. Guthrie at the International Home and Housewares Show earlier this year and found him to be highly engaged in the SodaStream story. Having been in talks with SodaStream for roughly 9 months before officially joining the company, he was well-versed on the home carbonation category. Mr. Guthrie's background includes 25 years in the consumer product businesses with brands such as MTV, Disney (NYSE:DIS) and Pepsi (NYSE:PEP). Yes, Pepsi!

During the 1st quarter conference call, Mr. Guthrie recognized how the company can grow the Americas business into the foreseeable future and with similar results to SodaStream's more mature markets by stating the following: "We will evolve from a small appliance business to a beverage business focused on taste and product benefits led by empowerment in health and wellness."

I never truly believed that SodaStream was making the soundest decision when it leaped from in-store product demonstration marketing to a combination of in-store product demonstration and commercial television marketing in the United States. Essentially, this product category is too revolutionary and contains too many beneficial characteristics, which make it hard to deliver the appropriate message to the consumer in a 30 second T.V. commercial. Simply throwing the product on television in a playful way doesn't tell the consumer why they should buy the product. The narrative for why the consumer should buy a SodaStream is simply too long. For example:

"SodaStream offers a healthier alternative to traditional store-bought sodas and does not contain high fructose corn syrup, has 1/3 less calories, 1/3 less sugars, 1/3 less carbohydrates, does not contain aspartame, has less sodium per liter, is more eco-friendly, takes up less storage in the cupboard, pantry and fridge, doesn't require a bottle deposit, requires less "schlepping", allows for complete drink customization of flavoring and level of carbonation, holds carbonation longer due to the hermetically sealed bottle and is on-par or slightly more economical than Coke (NYSE:KO) or Pepsi on a per-liter basis and now has over 70 flavors to choose from."

Now take that narrative and try to position a dramatic scene, which outlines this narrative in a way that can be comprehended by the consumer in 30 seconds. Not so easy is it?

We can see the changes implemented by Mr. Guthrie in the marketing strategy already underway. For the last two years, SodaStream has implemented television commercials leading up to Mother's Day in order to drive brand and product awareness. This year, there were no commercials in the U.S. market ahead of Mother's Day; however, we did see more in-store product demonstrations at the likes of Bed Bath & Beyond, as well as Williams Sonoma (NYSE:WSM). On the 1st quarter conference call, Mr. Guthrie denoted that they will increase in-store demonstrations by roughly 6 times last year's rate. In addition to general marketing strategies, Mr. Guthrie and his team are employing a promotional pricing strategy that is aimed at normalizing inventory levels at key retailers and assisting with getting these retailers prepared for the heaviest ordering cycle of the year, the 3rd quarter pre-holiday ordering cycle. This new promotional pricing strategy is now taking effect at retailers such as Wal-Mart and Bed Bath & Beyond.

Scott Guthrie also has another objective in mind for the U.S. market, which may take form at the very tail-end of this year. With his broad-based understanding of the home goods and grocery category, Mr. Guthrie is well aware of the potential for sales growth should SodaStream receive dual product placement in retailers such as Wal-Mart and/or Target (NYSE:TGT). SodaStream products currently have a designated home location within the small appliance section of these two hypermarket retailers. The small appliance section of these stores is one of the least trafficked areas of the store. With both retailers having grocery areas in their stores, there is the potential for SodaStream to expand its in-store placement in the near future beyond the small appliance section in a similar fashion as Keurig products are found in both areas of Wal-Mart and Target stores. Wal-Mart is the most likely candidate for such product placement expansion, especially since SodaStream has expanded its co-branding partnerships to include V8 Fusion, V8 Splash, Skinny Girl and Sunny D most recently. Wal-Mart's largest selling juice brand just happens to be Sunny D and Skinny Girl recently broadened its product line to include flavor enhancers which are available in Wal-Mart's ready-to-drink juice aisle. I would keep an eye out for this possible product placement development later this year.

Many are not aware of just how much health and wellness are playing a role in consumer food and beverage choices. Nonetheless, a recent survey (subscription necessary) conducted by the International Food Information Council Foundation (IFIC) shows that the consumer is considering healthfulness more so than ever before. According to the IFIC's 2014 Food & Health Survey, healthfulness was a key factor for 71% of U.S. consumers when making food and beverage purchases, a 10% leap from 2012. The survey also pointed to significant gains within a number of demographic groups. IFIC noted that 66% of 18-34 consumers cited healthfulness as a driver of food and beverage purchases, up from 55% in 2013, a jump that significantly narrowed the gap with other age groups. Male consumers who said that healthfulness is an important factor in purchasing decisions rose from 56% last year to 65% this year, while 67% of non-college graduates indicated their purchasing decisions were impacted by healthfulness, up from 61% in 2013.

When it comes to diet and healthfulness, 79% of consumers said that they have cut calories by drinking water or low- and no-calorie beverages, and 83% reported that have attempted to eat more fruits and vegetables within the past year or for more than a year. Seventy-two percent of consumers reported that they are eating more grains.

SodaStream is very much positioned to benefit from the wellness trend in consumption habits that is continuing to grow year-over-year. Late in the 1st quarter, SodaStream launched a new line of "Free" flavors which are free of artificial sweeteners, flavors, colors and preservatives. The Free line has now been expanded into Wal-Mart with two flavors and more to come.

As we wrap up the 1st quarter results, we recognize SodaStream's guidance. Even though SodaStream easily beat analysts' estimates for the 1st quarter, the company maintained its full year outlook for revenues and net income. The company expects Western Europe to grow slightly ahead of its initial forecast and the Americas to grow slightly slower than forecasted. Additionally, the company expects FY14 gross margins to come in flat vs. FY13 at approximately 51 percent. To put this gross margin expectation into perspective, which is SodaStream's lowest annual gross margin expectation since going public in 2010, the most similar business model to that of SodaStream is the Keurig Green Mountain business (NASDAQ:GMCR), which generally sees peak gross margins around 41% in a good coffee bean procurement cycle. It's always beneficial to put such metrics into their most appropriate perspective to better understand the potential impact to the business on the upside and the downside.

Source: Taking A Closer Look At SodaStream's Q1 2014 Results