The first thing that strikes us about Dr. Pepper Snapple (NYSE:DPS) is just how profitable it is. For example, last year it was able to post extremely strong return on equity and return on asset numbers, with the company reporting return on equity of 31.8% and return on assets of 9.1%. Sure, return on equity was boosted through the company running a fairly high amount of financial gearing, with its debt to equity ratio currently being 115.6%. However, we feel that this shouldn't cause many problems for the company going forward, since its interest cover is a very healthy 5.4. As such, we think that interest rate risk is comfortable and that Dr. Pepper Snapple's bottom line shouldn't be hit unduly hard by interest rate rises over the medium term.
Indeed, the return on assets figure mentioned shows that the company continues to make efficient use of its asset base. Meanwhile, operating margins of 20.4% last year again highlight an efficient, highly profitable business model that doesn't seem to contain too much waste nor that requires an overhaul of its operations to drive profit growth.
We were surprised to see that Dr. Pepper Snapple yields 2.7%. That's just 10% below the key 3% level that many income seeking investors hold out for. However, we were surprised because Dr. Pepper Snapple has a relatively low dividend payout ratio and yet yields much more than the S&P 500 (which has a yield of around 2%). Therefore, there seems to be a significant amount of potential for Dr. Pepper Snapple to become more generous with regard to shareholder payouts, which could make the stock even more attractive as an income play.
In addition, Dr. Pepper Snapple continues to offer strong growth prospects. Earnings are forecast to grow by 6.2% next year, which is roughly in-line with the wider index.
Despite all of the above, Dr. Pepper Snapple appears to offer very good value for money right now. For instance, it trades on a forward P/E of just 15.9, while the S&P 500 has a forward P/E of 16.2. Although only a small discount of 1.9%, we feel that due to Dr. Pepper Snapple's high level of profitability, it deserves to trade at a premium to the wider market. Therefore, we feel that there is upside on a relative as well as absolute basis.
Furthermore, Dr. Pepper Snapple has a PEG ratio of 2.2 and an EV/EBITDA ratio of 9.7, which again we feel are simply too low when the quality of the company is taken into account. As a result, we think that Dr. Pepper Snapple could see its valuation multiples expand going forward.
Dr. Pepper Snapple is a highly profitable company that does not appear to be taking excessive risk with regard to how it is financed. Furthermore, it is a relatively attractive income play, with the potential to become even more so as a result of it having a fairly low payout ratio. In addition, it has growth potential, all of which we feel are not currently reflected in its valuation multiples, as shown by a relatively low P/E and attractive PEG and EV/EBITDA ratios. As a result, we're bullish on Dr. Pepper Snapple and believe that it could make gains as the market acts upon what appears to be a mispricing through bidding up the company's share price.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.