Monster Beverage Corp. (MNST) is not the leader in the energy drink category, but it is running a close second in a highly competitive market. Investors in MNST have been richly rewarded by the company's vast expansion plan, which has proven to feed through to the bottom line earnings results over the last few years. As I have outlined before, and in a previous article concerning MNST, I would suggest to investors that the current quarter is the toughest the company has faced in quite a long time.
For the sake of saving readers time, I will list the obstacles the company is facing in the current quarter and for the foreseeable future.
- Distributor issues in Central and Western Europe.
- Distributor issues in Brazil.
- Lofty comparison from Hungary pipeline build in Q3 2011 due to tax implementation.
- Continuation of high costs associated with Asia Pacific expansion efforts i.e. Korea and Japan markets.
- Lower sales in both Brazil and Australia while the company reduces A&P spend in the regions.
- Ever increasing SG&A expenditures.
- Expectations to continue opening new markets in the quarter such as Chile, Peru and Taiwan.
- Pricing pressure brought on by an increase in competition for both majors and private label competitors.
- The potential ceiling created by the high input costs of goods and distribution, forcing the high costs imposed by energy drink makers through to consumers.
- Normal slowing of sales as we head into the back half of the year.
- Continuation of a change in drinking habits among consumers as they switch to more healthy alternatives.
- Two active class action lawsuits with indeterminate expenses.
- One class action settlement with indeterminate expenses.
If you have wondered why there hasn't been another major beverage distributor in the world over the last several decades, look no further than the above mentioned issues a potential major beverage company would have to face. The fact is that Coke (KO) and Pepsi (PEP) have dominated the beverage world due to their respective distribution strength which they created over the last 100 years or so. New comers to the industry are therefore forced to partner with the major's distributor or subject themselves to second and 3rd tier distribution partners who have less resources and retail reach in the marketplace. As notated in Monster's 10Q filings, in several regions, they do utilize the major's distributor, but in those which they do not, they have seen the expected difficulties encountered by the alternative distributors in the different regions for which they operate. Reaching a fair and equitable profit in these specific regions has been and remains an obstacle for Monster as they toy with decreasing expenditures and increase retail reach in these regions.
We believe that Monster is on the precipice with several of these tier two and three distribution partners for which the company has to make more long lasting decisions that would propose to enhance profitability in these respective regions. If they fail to address these issues in a timely manner, the lofty multiple which investors have enjoyed could all disappear. In a sense, these expected YOY gains through initial pipeline builds, in said regions, will have to be offset in other regions or realized with greater losses. The company does have several options with regards to addressing distributor issues, which are outlined in the link posted above. However, each option requires the company to increase capital expenditures and take on subsequent margin contraction which will likely feed through to the stock price in a negative way.
Now for the positives which the company can expect in the future. Truth be told, if one does some serious analysis of the company's previous results and speculates forward into the future, there really aren't that many positives for shareholders and the stock valuation. The company has already begun seeing a moderated growth rate this year, and expectations offered by analysts suggest further moderation of that growth rate in 2013 and beyond as the company penetrates the remaining markets left around the world. More specifically, Stifel Nicolaus' analyst now sees Monster's growth rate in the mid-teens going forward. The growth rate is naturally going to slow as a company matures, but this is where investors have to accept the potential for a more moderated growth rate in the stock price as well which is usually seen by a rather sharp correction in the direction of the stock price initially as the valuation is reset. It happens to almost every categorized growth company at some point in the stock's history, and I think we may see it in MNST in the very near future. There are growth stocks, dividend stocks, but have you ever heard of moderated growth stocks? I do hope that I'm wrong. The company does have a strong buyback plan in place, but it has yet to act upon it.
So what can the company do as it matures and achieves a more sustainable growth rate? It really is quite simple, and as we understand at Capital Ladder Advisory Group, LLC, the company may be in talks with SodaStream International (SODA) to create a co-branding deal. A co-branding deal, what's that? First, if you haven't heard of Soda Stream International, here are some details on what the company has to offer. If one of the problems which Monster is encountering is distribution, Soda Stream can offer Monster a whole new channel of distribution for its product line. The Soda Stream system is an at-home carbonation system which allows the consumer to create their own carbonated drinks at home. Soda Stream has products in 43 countries around the world and is in many of the same markets as Monster. In fact, some of the countries which Monster struggles for profitability are widely penetrated by Soda Stream. SODA has over 150 different flavored syrups to offer the consumer and at least four energy drink syrups which are among the company's most popular flavored syrups.
All over the world, government bodies are finding themselves in the precarious position of needing to find additional funds. Tax implementation is on the rise and many countries have adopted soda beverage taxes while existing soda taxes in other countries have risen like in France earlier this year. France isn't the only country with a tax on soda beverages, Mexico has a tax on soda products and the U.K. is also ready to introduce a tax on sugar sweetened soda beverages . In Q3 of 2011, Hungary passed a tax on sugar sweetened soda beverages. Monster's distribution partner in Hungary was moved to initiate an oversized order of Monster products ahead of the implementation of the tax by the government which caused a disruption in that market. Now, Monster will have to comp to this large order in Q3 2012. Have investors considered this little regarded fact as a part of their quarterly due diligence? If you have ever wondered why companies miss estimates unexpectedly, it is usually because of these lesser referenced points of interest, usually glanced over or completely forgotten over time.
So what does this taxation issue have to do with the Monster business as a whole? Well, simply put, as taxation increases for soda products, Monster will have to offset this increased cost of goods by passing the cost on to the consumer. In many cases, as has been proven by recent quarterly reports from Pepsi and Coca-Cola, price hikes can and have resulted in lower volume of sales. Energy drinks already sell at a premium to other carbonated beverages. How much higher can energy drink producers raise prices before the consumer seeks an alternative.
Did I mention that the Soda Stream energy drinks only cost about 30 cents a can when compared to the average energy drink which costs between $2 and $3 a can? In recent taste tests, most consumers polled could not tell the difference in the taste between a Red Bull energy drink and a Soda Stream energy drink. Don't think for a minute that the markets Soda Stream operates within haven't identified this cost-per-can benefit of the Soda Stream system. Soda Stream's energy drinks are among its highest grossing SKUs for the company. Monster Beverage Corp. has a very identifiable opportunity here to enter into a partnership with Soda Stream; the synergies are becoming ever clearer.
Now let's talk about Brazil. In Monster's most recently reported quarterly results, the company noted that its Brazilian distributor was having issues with procuring ingredients for production and scaling the business in the region to meet the needs of the marketplace. I can't stress enough how important and impacting a distributor can be on any particular market as the distributor is directly charged with driving sales of a company's products and creating brand recognition through marketing efforts. These distributor issues can go from bad to worse in a blink of an eye. Soda Stream entered the Brazilian market in Q2 of 2012 through its partnership with Grupo M. Cassab, which distributes Soda Stream's products in the region. Grupo M. Cassab also distributes goods to Argentina which is another highly desired marketplace for both Monster Beverage Corp. and Soda Stream. And the synergies just keep on coming don't they?
It seems as though Soda Stream can really offer Monster a plethora of advantages through a co-branding relationship via an installed Soda Stream loyal user base in 42 countries and growing, a direct line to a cost conscience consumer and a new revenue stream void of potentially increased taxation hurdles. Soda Stream could also help Monster gain market share in the Nordics and Asia Pacific region. Soda Stream has already found success through its Soda Inside initiative. The company has an existing and thriving co-branding partnership in place with Kraft Foods (KFT). The partnership has proven to be so beneficial for both parties that the two companies recently expanded their deal to include additional Kraft brands which will be introduced for the Soda Stream system in the fourth quarter this year.
What Soda Stream essentially did for Kraft was to take two brands of Kraft, Country Time and Crystal Light, and revive them by offering Kraft an additional revenue stream for these brands. Soda Stream can do the same thing for Monster Beverage, or for that matter, any beverage maker. Let's not just assume that Soda Stream is the "Superman" of the beverage industry here, ready to save companies from taxation and possible slowing growth. Soda Stream will reap the benefits of strategic co-branding relationships too, especially with "tier one" beverage companies such as a Monster Beverage. As Soda Stream gains global presence, it could certainly attract new users to the product placement in stores with a highly identifiable and popular brand logo like a Monster Beverage logo or a Dr. Pepper logo, shelved along with their proprietary brand products. Such tier one brands would also lend credence to the efficacy of the Soda Stream system and help to eliminate the "fad" cache that has plagued the company in newer markets.
Essentially, Soda Stream will benefit from loyal brand consumers whom are not currently partners with Soda Stream. If all you drink is Monster Beverage or Dr. Pepper (DPS), you may not ever use a Soda Stream, but with a co-branding partnership that would offer these branded flavors through the Soda Stream system, you might very well change your mind. It happened for GMCR through its licensing relationships with Folgers, Dunkin Brands (DNKN) and Starbucks (SBUX). The same principles could apply and have been working with Soda Stream and Kraft through their partnership.
Soda Stream has recently found itself to be a highly sought after commodity as it further develops the home carbonation industry on a global scale, offering a new product segment and consumer base for additional partners to enjoy. The company recently signed another Soda Inside deal with Breville Group Limited to produce a new soda machine which will be powered by Soda Stream .
A deal is brewing, but who will be next to partner with Soda Stream is still up for debate. If you take the time to listen to Soda Stream's recent quarterly conference call, the company's management team discusses how they are in discussions with tier one beverage companies with regards to a co-branding deal. Additionally, the company also discussed their desire to aggressively participate in the energy drink market in the back half of the current fiscal year. Well, what does this last statement mean? Soda Stream already offers energy drink flavored syrups and newly developed vitamin enhanced syrups. At Capital Ladder Advisory Group, we put the two above mentioned statements together and draw our own conclusion. Could Monster be the next partner for Soda Stream or will it be Red Bull or Rock Star? It could also be Dr. Pepper Snapple Group which offers a variety of carbonated beverages which includes its Venom energy drink product.
I almost forgot to mention the synergy which is easily identifiable for the Korean market which Monster is eagerly trying to penetrate with a lack of success over the prior six-month period. Much of the incurred costs of doing business in the Asia Pacific is coming from Japan's intense quality assurance procedures and the fact that Korea does not permit energy drinks with certain ingredients if at all. Monster continues to incur expenses in Korea while its products sit at the port of entry, needing to be stored and secured there, and at a cost to the company. Investors are looking for an update on Korea when the company reports in October.
So what does this expansion effort into Korea by Monster Beverage have to do with Soda Stream? Good question indeed. Soda Stream offers the consumer the ability to dose their beverage of choice and personalize the beverage to desired tastes via their home carbonating soda machine and flavored syrups. Because it is a self-dosing system, in many countries, Soda Stream's system is not exposed to the same regulations and/or taxation of certain governing bodies. There is another synergy we forgot to mention with regards to taxation. One of the main reasons Soda Stream flavored syrups don't fall under the realm of such government taxation is because its flavored syrups do not contain high fructose corn syrup. As a point of interest, Soda Stream offers several energy drink syrups around the world and has a growing consumer base in Korea.
Monster Beverage Corp. will need to address all the issues noted in this article and Soda Stream has admittedly been talking with a number of major beverage companies. The synergies certainly align themselves for Monster Beverage Corp. and Soda Stream International, but as SODA is so highly sought after in these uncertain economic times, whoever offers SODA the best deal will likely be the next co-branding partner announced by this rapidly growing company.
Disclosure: I am long SODA.