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Summary

  • This article discusses why Dr Pepper Snapple offers a better alpha opportunity than sector peers PepsiCo and Coca-Cola.
  • It focuses on the relative strengths and weaknesses of Dr Pepper Snapple versus its two rivals based on business performance, sustainability/dividends and value.
  • It concludes by detailing the alpha opportunity that we feel is on offer at Dr Pepper Snapple.

In this latest installment of our Alpha Opportunities series, we discuss why Dr Pepper Snapple (NYSE:DPS) is a better buy than PepsiCo (NYSE:PEP) and Coca-Cola (NYSE:KO).

Dr Pepper Snapple Background

Dr Pepper Snapple Group, Inc. was incorporated in 2007 and is headquartered in Plano, Texas. It operates as a brand owner, manufacturer, and distributor of non-alcoholic beverages in the United States, Canada, Mexico, and the Caribbean. The company operates in three segments: Beverage Concentrates, Packaged Beverages, and Latin America Beverages. It offers a portfolio of flavored (non-cola) carbonated soft drinks (CSDs) and non-carbonated beverages (NCBs), including ready-to-drink teas, juices, juice drinks, mixers, and water. The company's brand portfolio includes Dr Pepper, Canada Dry, 7UP, Squirt and Crush.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We score each company relative to its peers on the following criteria within each of our 2 main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Sustainability/Dividends

  1. Debt to equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Yield
  5. 5-year average yield

Once we have scores for the 2 buckets, we can then assess whether there is an alpha opportunity available given the current valuations of the 3 stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Price to earnings ratio
  2. Price to book value ratio
  3. Enterprise value to EBITDA
  4. Price to sales ratio
  5. 5-year price to earnings growth ratio

So, for example, a company that scores well relative to its peers on the first two buckets (business performance and sustainability/dividends) and that is undervalued relative to its peers (based on the third bucket: valuation) would be considered an alpha opportunity. In such a case, we would generate a target price for the alpha opportunity that is prudent relative to the valuations of its peers.

The table below highlights the data that we will use to score Coca-Cola, PepsiCo and Dr Pepper Snapple on a relative basis for the first two buckets.

Stock

Coca-Cola

PepsiCo

Dr Pepper Snapple

Business Performance

Return on equity

25.78%

30.55%

30.15%

Return on assets

7.72%

8.27%

8.52%

Operating margins

23.93%

15.22%

19.39%

Quarterly rev. growth

-4.20%

0.30%

1.30%

Quarterly EPS growth

-7.50%

13.10%

46.20%

Sustainability/Dividends

Debt to equity ratio

116.77%

140.10%

121.16%

Interest cover

18.78

9.04

10.08

Dividend payout ratio

61.00%

51.00%

47.00%

Dividend yield

2.90%

2.90%

2.70%

5-year average yield

2.80%

3.00%

2.90%

We then rank each company relative to its peers based on the above data, with scores being awarded as follows:

1st place relative to peers: 10 points

2nd place relative to peers: 5 points

3rd place relative to peers: 0 points

Below are the scores for Coca-Cola, PepsiCo and Dr Pepper Snapple:

Stock

Coca-Cola

PepsiCo

Dr Pepper Snapple

Business Performance

Return on equity

0

10

5

Return on assets

0

5

10

Operating margins

10

0

5

Quarterly rev. growth

0

5

10

Quarterly EPS growth

0

5

10

Sustainability/Dividends

Debt to equity ratio

10

0

5

Interest cover

10

0

5

Dividend payout ratio

0

5

10

Dividend yield

7.5

7.5

0

5-year average yield

0

10

5

Total Score

37.5

47.5

65

As you can see, Dr Pepper Snapple scored the highest relative to its two peers. We are particularly impressed with its business performance, where its strong quarterly earnings and quarterly revenue growth helped it to bet Coca-Cola and PepsiCo. Furthermore, the company's debt levels and interest cover, although not sector-leading, appear to be impressive enough to say that Dr Pepper Snapple is a highly sustainable business. In addition, a low dividend payout ratio means that the forward yield of 2.7% has the scope to increase significantly.

Meanwhile, Coca-Cola's performance lagged that of PepsiCo and Dr Pepper Snapple due to its disappointing business performance. Indeed, it scored bottom of the three companies in all but operating margins, while its main strength was sustainability - lower debt and better interest cover mean the Coca-Cola brand looks highly sustainable.

PepsiCo, although offering investors a great return on equity, continues to run higher levels of leverage than sector peers. In addition, while its business performance was noticeably better than that of Coca-Cola (especially with regard to quarterly revenue and quarterly earnings growth), it remains some way behind Dr Pepper Snapple on this front.

Alpha Opportunity?

So, we feel that Dr Pepper Snapple is a higher quality stock than its two main rivals, PepsiCo and Coca-Cola. Therefore, we believe it should trade at a premium to its two rivals. Let's see whether it does.

Stock

Coca-Cola

PepsiCo

Dr Pepper Snapple

Valuation

Price to earnings ratio

18.81

18.38

16.03

Price to book ratio

5.68

5.97

5.26

EV/EBITDA

15.65

12.62

10.22

PEG

3.02

2.75

2.36

Price to sales ratio

4.00

2.05

1.93

As well as being the highest quality company, Dr Pepper Snapple appears to offer the best value of the three. For example, its P/E ratio, price to book ratio, EV/EBITDA multiple, PEG and price to sales ratios are all lower (and more attractive) than those of Coca-Cola and PepsiCo. Therefore, we feel there is an alpha opportunity going long on Dr Pepper Snapple.

Target Price

With a strong showing in the business performance and sustainability/dividends buckets, we feel that Dr Pepper Snapple deserves to trade at a premium to PepsiCo and Coca-Cola. However, being conservative investors, we will be prudent and use the higher of Coca-Cola and PepsiCo's P/Es to generate a target price for Dr Pepper Snapple. As such, a P/E ratio of 18.81 (the same as that of Coca-Cola) seems appropriate, given Dr Pepper Snapple's strong performance in the business performance and sustainability/dividend buckets.

This generates a target price of $69.04, which is 17.3% higher than the current share price of $58.84.

Conclusion

Dr Pepper Snapple is a great company that we believe offers the opportunity to generate alpha. It scored highly on the Team Money Research rating system, beating its two main rivals. It also appears to be undervalued at current levels and, as such, could be a strong performer over the medium term.

Stock

Dr Pepper Snapple

Team Money Research View

Buy

Team Money Research Target Price

$69.04

What do you think of Coca-Cola, PepsiCo and Dr Pepper Snapple? Please share your views below…

Source: Why Dr Pepper Snapple Is A Better Buy Than PepsiCo Or Coca-Cola