Around the world and here in the U.S. the growth of the bottled water sector continues to increase. This demand requires beverage companies, both large and small, solely water-focused and not, to increase their CAGR in this subsector in order to capture upside returns.
Refreshing Through CAGR
Worldwide, the bottled water market keeps flowing with current estimates of CAGR at 10.7 percent, translating into anticipated sales of approximately $195 billion over the next four years.
Notably, the largest portion of this global market is unflavored water, which is anticipated to reach $166 billion by 2018 with CAGR at 10.5 percent. A deeper dive reveals that flavored and functional water are anticipated to see the largest growth to approximately $29 billion over the same period with CAGR at 12 percent.
Three global beverage companies that reflect growth in CAGR are: PepsiCo Inc. (NYSE:PEP), The Coca-Cola Company (NYSE:KO), and Danone SA (ADR) (OTCQX:DANOY). As investors will note, each of these large caps have reported earnings that vary in metrics, but are similarly based on market share expansion in this subsector, as bottled water demand drives sales.
In the hot market for bottled water, PepsiCo Inc., is our first CAGR example. Demonstrating its increasing market share, with its stock undervalued (see: Seeking Alpha article, PepsiCo: One Of The Best Beverage Stocks), PEP has been on the climb since the beginning of the year by over seven percent.
Most importantly, PEP, early this year began investing $5 billion in Mexico. Mexico - behind the U.S. and Russia - is Pepsi's third largest market. In 2012, the country generated $4 billion or six percent of PEP's global sales. We anticipate these plans for expansion will translate to Pepsi's continued earnings per share, which today are at $4.42.
Investors might be interested to know that the largest-volume by consumption market is from Mexico, where it is estimated that the average citizen buys 260 liters of bottled water per capita, annually.
As The Coca-Cola Company climbs up near its 52-week high, we give the classic giant high watermarks for its recent gross profit margin at a 65.87 percent, and for its matching and leading $5 billion dollar investment in Mexico.
In some markets, specifically emerging markets, lack of access to clean water makes the product a necessity. Although, investors should not focus solely on environmental drivers. To that end, investors should note in the developing world, with the largest population aggregates, consumption levels are in the single digits.
In France, Italy, Germany and Spain, however, consumption per capita ranges from 200 liters to 100 liters, which is also why we like the big consumer bottled water seller Danone SA (ADR).
In Europe, the Company's main markets indeed are France, the United Kingdom, Germany, Spain, Italy, Belgium, Netherlands, Luxembourg, Poland and Russia.
The French-based food and beverage company is the producer and distributor of bottled water brands: Evian, Volvic, Aqua, Bonafont, Font Vella and Lanjaron. The water business line focuses on natural or flavored mineral water, and on fruit-flavored or tea drinks, by positioning the health benefits.
For a range of reasons, including health concerns and technological advancements, the price for consumer driven, bottled water has lowered worldwide. This fact has enabled Danone AQUA to expand its global reach beyond its European and U.S. markets, with a quench for some of those emerging markets.
Specifically, as of this past May, the Company announced its plans to double annual capacity to 20 billion liters of bottled water in Indonesia over the next three to five years. Indonesia is the world's fourth largest country with a population of approximately 240 million people and Southeast Asia's largest economy.
To date, Danone AQUA accounts for 40 percent of Indonesia's bottled water market and plans to add 10 more production and distribution plants to its current count of 17.
Factoring inflation, it has been estimated by Euromonitor International that over the next four years, the value of Indonesian bottled water market will surge 66.1 percent to 44.9 trillion rupiah or $3.9 billion.
Today, a 1.5 liter bottle of AQUA sells for approximately 3,000 rupiah ($0.26), while premium brands such as Evian, also sold by Danone and available in the Indonesian market, sell for at least double that price.
What really quenches our thirst for Alpha and why we like Danone is that in Indonesia there are almost no bottled water marketing campaigns, which translates into huge market potential.
Tapping Enhanced Technology
The advent of the microcap bottled water sector was in the 1990s in the U.S. with a growth rate that very nearly continues today. That is, the bottled water market continues to outpace the beverage market as a whole, with over 20 percent growth each quarter between 1993 and 2005.
While not quite at that percent growth today, the U.S. bottled water sector is still on top as one of the leading consumer sub-markets. Indeed, bottled water sales now surpass, and have been surpassing soda sales since the mid-2000s. Market analysts anticipate that bottled water will become the number one packaged beverage sold in the U.S. by 2020.
According to the International Bottled Water Association, "The vast majority of bottled water companies in the United States are small, about ten employees or less, and generate less than $10 million in sales annually."
To understand how the subsector began overtaking traditional soda sales, and what new technologies are flowing, investors should look to these smaller bottled water companies which have led the way in innovation. One such company is The Alkaline Water Company Inc. (OTCQB:WTER) sells its main product, Alkaline88, in 49 of the U.S. states and the District of Columbia, representing 6,000 retail outlets.
The Company's primary marketing focus is the health benefits of ionized water. So why is the technology of ionized water important for investors to understand? Health benefits aside, ionized waters and vitamin-enhanced waters are now the focus throughout the subsector.
Indeed, enhanced waters that promote such benefits - such as ionization, antioxidants, and vitamins A, C and E - lead market campaigns today. For example, Kraft's (KRFT) Fruit 20 line, Sober Life Water's focus on natural sugars, Kellogg's (NYSE:K) Special K20 protein water, Gatorade's Propel Calcium, Glaceau's 15 vitamin water flavors and Coke's Vitaminwater all represent the enhanced technologies and branding which have shaped the market to date.
H2O Makes for Healthy Returns
As the healthier alternative to sodas, water and specialized waters are, however, also healthy for stabilizing and increasing share value.
As of this week, both Pepsi and Coke reported earnings. Pepsi beat analysts' quarterly expectations of $1.23 per share, reporting $1.32 per share on $16.89 billion in revenue.
Organic revenue increased two percent in the beverage divisions, while the snack division reported a five percent increase. Organic revenue from developing and emerging markets where water is a focus, however, increased eight percent.
Contrary to our view, some skeptics, such as those at The Street suggest that the company has underperformed both compared with the industry and in regards to gross profit versus net profit. They make the point that at 9.63 percent net profit the Company, "trails the industry average." We respectfully disagree with their analysis.
For a longer-time horizon, when comparing the current day's price of ~$90.34 to the Dow and the S&P 500 at six, three and one months, PEP has outperformed both.
Perhaps this is why UBS raised its target $12 to $95. Regardless of differing opinions, we are focusing on the reality that PEP is looking to increase its market share on a global scale and has executed this plan with the recognition that bottled water is a key driver of growth.
For investors who have not looked at Coke recently, KO owns or licenses more than 500 nonalcoholic beverage brands, primarily carbonated beverages but also a variety of still beverages, including: waters, enhanced waters, juices and juice drinks, bottled teas and coffees, and energy and sports drinks.
This week the Classic giant reported earnings with beverage volume increasing five percent. Packaged water volume gained six percent with enhanced water or sports drinks gaining seven percent compared to the previous quarter.
In total, KO reported $12.6 billion in Q2 net operating revenue, a decline of one percent from Q2 of last year. While volume has increased, revenue has declined by three percent in the first half of the year. Net income for Q2 was $2.6 billion or a three percent decline from the prior year.
Regionally, unit volume increased across the board by three percent companywide for the quarter. Eurasia and Africa, and Asia-Pacific, reporting five percent and eight percent volume growth respectively. Improvement was noted throughout Europe as well. The global numbers revealed consumers shift toward healthier options such as: bottled water (7%+), teas (4%), and sports drinks (6%+) outperforming standard beverages.
Given the size and demand of the bottled water markets, both tapped and untapped, investors are advised to remember that in just four years, the anticipated 34.5 percent increase in the total value - including sales - of the global bottled-water market is expected to reach $254.4 billion.
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