Has SODA Gone Flat?
On Wednesday, May 2, Green Mountain Coffee Roasters (GMCR) disappointed the markets with first quarter earnings [see transcript] that saw a decrease in growth and its stock got punished severely. At the same time we saw SodaStream (SODA) get a hefty chunk taken out of it on no significant news.
Is the market correct in thinking that SODA will suffer the same fate as GMCR on Wednesday, May 9, when first quarter earnings are reported before the market opens?
SODA manufactures and sells home carbonation devices on a roughly razor-blade model popularized by Gillette and Green Mountain Coffee Roasters. Carbonation machines are sold at near cost with higher margin carbonation refills and flavored syrups providing continued revenue from the installed base.
The brand is a lot older than many in the US might realize. Originally operated as a subsidiary of W & A Gilbey, Ltd in 1903, SodaStream has been selling the idea of home carbonation for a while now. After experiencing popularity in the UK during the 1970s, the company waned in the 90s and did not start making waves until its acquisition by Israel based Soda-Club in 1998. Since the acquisition, the company has seen sustained growth due to innovative product offerings and a commitment to quality design.
SODA IPOed at $23.15 on November 3, 2010 and has since traded from an all time high of $79.72 in July 2011 to a more recent low of $27.60 in November 2011. It closed on Friday, May 4 2012 at $30.58, much closer to the lows than many feel is justified.
Consumer Value Proposition
Of the many selling points of SodaStream machines (healthier, good for the environment, less storage required, flavor diversity, on demand availability), the one that is easiest to quantify and compare to the competition is the value proposition of home carbonation for the consumer.
First, let's establish some comparisons. Biggest kid on the soda block is obviously Coca Cola (KO) with Pepsi (PEP) coming in right behind them so I will get some average prices for 12 pack cans and 2 liter bottles (not on sale)….
12 pack cans of Coke = ~$4.50 or $1.05 per liter
2L of Coke = ~$2.00 or $1.00 per liter
Prices may vary by location but a quick perusal of the prices in my area come in around these prices. For the sake of keeping the math simpler, let's say the major competition for SODA products come in at about $1.00 per liter when not on sale.
Now we will break down SODA's costs to make a liter of home carbonated pop.
60L CO2 cartridge = $15.00 or $0.25 per liter
15L flavored syrup = $6.00 or $0.40 per liter
Add the CO2 costs to the syrup costs and you come out with a $0.35 per liter savings versus the competition.
What about the sunk costs of the carbonator itself, you ask?
Well, if you did not get it as a gift and had to shell out the $80 for the base model, you would make it back after making 228L of Soda at home. That sounds like an awful lot, but when you consider that the average American consumes over 200L a year of soda (not counting carbonated water, for which the value proposition for SodaStream is highly superior to Perrier, etc.) you are looking at a ROI time frame in a little over a year for a single user and just under 3 months for a family of 4.
Taking that average family of 4 consuming their average 800L of pop, you have a total cost of $600 with a SodaStream on the initial year and $800 for the name brands. Year 2 is even better as the SodaStream is effectively paid for and the savings grow by 40% from $200 to $280. Getting a carbonator as a gift is even better with the savings coming in immediately and stacking up over time.
Now, as many will probably argue, no one pays retail for Coke or Pepsi as sales are plentiful due to the large number of stores that carry the products.
So let's say you can get Coke for 33% less or $0.67 per liter. You have drastically slashed the savings of a SODA machine from a healthy $0.35 to a measly $0.02 per liter. I won't bother doing the ROI time frame for this savings, it stinks. Since all is fair in love and war, we should be able to apply the available discounts to SODA products as well.
Bed, Bath and Beyond (BBBY) regularly sends out $5 off and 20% off coupons that can be used for your SODA products. Applying the $5 off on the $15 CO2 cartridge and 20% off on the $6 syrups brings our cost per liter back down to $0.49. This takes our savings back up to a healthier $0.18 per liter.
Can name brand soda be found for less than $0.67 per liter? Of course. If you can regularly find 12 packs for better than $2.08 or 2L for less than $0.98 then the value proposition for a SODA carbonation device is not there for you.
First Quarter Expectations
After the GMCR implosion, the first quarter results to be released next Wednesday are going to be critical for any playing a long position in SODA.
|Market Expects||Company Guidance|
|Period||Gross Revenue||EPS||Gross Revenue||EPS|
Source: Yahoo Finance Stated in USD (Actually in Euros)
Currently the market is expecting 26% growth on the top line and 33% growth on the bottom. Take their 2012 estimated EPS and throw it at their current share price of 30.58 and you have a Forward P/E of 19, well under their projected earnings growth rate. That disconnect is deceiving as the company is actually priced much lower than the Yahoo Finance numbers would indicate.
Since the IPO, SODA has been reporting using Euros and converting to dollars for Wall Street. I can't count the number of times that people have referenced the future earnings in Euros and compared it to the current price in dollars. Even Yahoo Finance says that the numbers are stated in USD, but that is patently untrue and hopefully will be updated once the company starts reporting in USD this quarter.
Convert the EPS expectations into USD and you get $2.093 for 2012 earnings and a Forward P/E of 14.61. 14.61 for a company projected to grow double what that number would indicate!
In today's market conditions, P/E ratios, both trailing and future, are not what they used to be. Gone are the days of Graham's 20 P/E being exorbitant and 10 being the norm. Apple (AAPL) shows that P/E does not always reflect a company's earnings growth by having a P/E well below their growth rate, while Amazon (AMZN) and Salesforce (CRM) prove that P/Es can have little to no impact on how the market values a particular equity. While I believe AAPL is suffering almost from too much success (it's already the biggest company on the market) and AMZN is benefiting from a belief of future success (can't grow the bottom line with Miracle Gro), the P/E ratio at least provides us with a measuring stick to compare equities in drastically different industries.
Could SODA benefit from finally making the move to report in USD instead of Euros?
The analyst community is filled with sharp knives and dull rocks. I would not put it past some of them to be using the results posted in Euros and comparing it to other information reported in USD. We don't get calls for Netflix (NFLX) to new all time highs right in front of an implosion if the analyst community is firing on all cylinders. There could be quite the surprise for any analyst that is expecting to see EPS come in at 0.36 when the company reports 0.47 just due to the currency conversion.
Short interest on SODA is always high due to fad concerns. As of close on Friday, May 4 the short interest stands at 10.2M shares on a total of 17.67M shares with days to cover ratio at 10.8. With 58% of the total shares being held short, the potential for a short squeeze on a good report makes a short term trade on SODA look pretty enticing, especially if the report changing to USD catches a few analysts looking the other way.
Back to the Future
While market conditions are not entirely favorable right now with GMCR getting hacked apart just a week in front of earnings, SODA has a few things in the pipeline that could benefit any long term holders of the stock.
SodaStream announced its first licensing deal with Kraft (KFT) to distribute County Time and Crystal Light branded flavored syrups in January of this year. The syrups are planned to roll out this summer and will be SODA's first foray into selling branded syrups. I view this as an important step and hope that they can continue to get more brand licensing deals in the future.
While Coke and Pepsi are obviously not going to play ball, I feel that to really gain traction in the US, SODA is going to need more brand recognition of their syrups to maintain momentum and customer uptake of the product in the long term. The US is an extremely brand sensitive market. People buy their one favorite flavor and rarely deviate from it. Growing up in Virginia, we called everything a Coke, regardless of the actual flavor. Brands are key in engaging the US consumer, especially when trying to break into a market with dominant 100 year old competition.
Dr. Pepper Snapple Group (DRP) is my ideal candidate for the next licensed syrup deal. Not only could I see Snapple getting really creative with their flavor offerings but DRP is not so large that they could not benefit from the team-up. Will it happen? Probably not, but of the name brand soda companies out there, it is at least the most likely candidate. If the Kraft partnership works out well, I hope they are able to bring more into the fold as it would benefit all parties involved and put even more pressure on the two main players in the soda market.
Plan of Attack
After trading SODA profitably through 2011, I have re-entered with a small position at 30.50. We have the EU elections over the weekend and that kept me from getting too deep as SODA has large European market exposure. Once the uncertainty clears up I hope to get fully positioned in front of earnings.
SODA normally trends up in front of earnings as the shorts cover to avoid a surprise but this quarter may be different. With the confidence of the shorts at record highs due to the GMCR implosion, I could easily see it hitting lower levels in front of earnings. Even with that possibility I feel that the reaction in SODA is overdone, especially as SODA has none of the inventory and fraud concerns that were seen with GMCR.
While SODA is definitely a bucking bronco of a stock, constantly under attack by short sellers, I feel that at least for this report, the shorts are getting ahead of themselves and could be looking for a quick exit on Wednesday.
Disclosure: I am long SODA. I plan on buying shares or selling puts in front of earnings on May 9.