Last week, Monster Beverage (NASDAQ:MNST) saw its stock price plunge for the second time in the last month. It looks like the regulators will want to have a talk with the company soon. Recently, two senators asked for tighter regulations regarding the energy drinks including but not limited to the labeling, ingredients and marketing practices surrounding these drinks. One article published on Seeking Alpha pointed this stock out as a good shorting candidate, but I strongly disagree.
Currently, the company's shares trade for low $50s, which is nearly 40% off from the stock's 52-week high price of $78 which was achieved in mid-June (not counting a takeover rumor-related spike in April). Most of the troubles in front of the company may be already baked in the share price by now. We don't know what the resulting decision will be at the end of the investigation, but many investors of the company seem to be prepared for the worst. Since the company didn't provide many details about the issue, we will have to consider every possible outcome and see what happens in each case.
The worst-case scenario is that the investigations find out that there is something horrible in energy drinks, and the company's products get banned forever in the USA. In this scenario, the company will have to market and sell its products in the international markets with the absence of the US market. It would take the company several years to recover from such damage, but eventually the international growth would make up for the losses in the US market.
Realistically, I don't believe that Monster's products will get banned. The energy drink segment is the fastest-growing segment within the beverage industry, and beverage giants such as Coca Cola (NYSE:KO) and Pepsi (NYSE:PEP) are trying to establish themselves in this market. Considering the lobbying power of these companies, they would fight very hard to make sure that the regulators will not ban energy drinks altogether. Besides, there are many products in the market that are bad for health, such as cigarettes, and it would be outrageous to ban energy drinks for good.
More realistically, the regulators may end up asking the energy drink companies to modify their ingredients in order to make their drinks healthier for the public. This could include things such as reducing the amount of caffeine per serving. This might change the taste of these drinks, and some people might stop buying them; however, the loss wouldn't be so great unless the ingredients of these energy drinks are changed so drastically that the energy drinks become something else. Monster is luckier than the competition when it comes to taste, as the company offers more than 20 flavors. If someone doesn't like one of Monster's flavors, they can always try other flavors.
The third possibility is that Monster is able to keep all its ingredients the way they are; however, the company is asked to put a warning label on the packaging to warn the consumers about possible health risks related to consuming these drinks. These labels might keep some of the over-consuming people from consuming too much Monster. This might hurt the company's sales in the short term; however, this would also save the company a lot of legal headache in the long term. Having Monster add a warning label to its drinks might end up being good for the company in the end.
The fourth possibility is that Monster gets fined by the regulators for the "unhealthiness" of its drinks. Government fines in similar cases tend to be equivalent of "slap to the wrist." For example, earlier this year, there were no implications for Coca Cola and Pepsi when the lab tests revealed possible carcinogenic agents in their drinks. Monster might not end up paying too much of a fine.
Three out of the four possibilities facing Monster aren't bad enough to warrant the company's loss of more than 30% in market value. The first possibility is bad enough to warrant such outcome; however, that is already priced in by now. Besides, it is extremely unlikely to happen as there aren't many cases where the government has completely banned certain beverages from the market.
When we look at some of the details surrounding the story, we see that things aren't as bad as investors of the company have feared. The senators specifically asked FDA to study the effects of the ingredients of energy drinks on children and teens. The focus of the study is likely to be the caffeine.
First, the senators didn't ask for the energy drinks to be regulated or banned; they simply asked them to be investigated. Second, the focus of the study is children and teens, meaning the regulators will not look to ban the product. If the intent was to have the product banned, the children and teens wouldn't be specified. Third, the investigation focuses on all energy drinks and this is not specific to Monster alone. It is far more difficult for regulators to fight an entire industry than a single company.
Outside of the regulation drama, the company is doing really well. Monster has accomplished an incredible rate of growth which isn't likely to slow down anytime soon. Over the last three years, the company's revenue has grown from $1 billion to $1.7 billion, signifying an increase of 70%. During the same period, the company's annual earnings per share increased from 55 cents to $1.53. Monster's balance sheet demonstrates lack of debt and nearly $800 million in cash and short-term equivalents. The company's strong balance sheet shows that it would take a huge fine to hurt the company. The company has a lot of potential to grow both in the US and outside as its energy drinks get introduced to two to three new countries each quarter.
I don't think anything serious will come out of the FDA study. The FDA will probably end up asking energy drink companies to add a warning label to the packaging of their products. The senators and regulators that are going after the energy drink companies are mostly worried about children and teens. A few years ago, similar concern was raised about Coca Cola and Pepsi. The regulators were concerned about the health-related outcomes of these drinks for the children. As a result, the two companies agreed not to air commercials and advertisements targeting children and the companies didn't get fined at all. Monster might also be asked to redesign its marketing efforts if its products are found to hurt children. I don't recall a time when a large beverage company was heavily punished by the regulators. In this case, the regulators don't even seem to be concerned about the effects of energy drinks on adults.
Currently, I wouldn't call Monster cheap or "value play," because Monster is a growth stock with some premium built into the stock price. Currently Monster's P/E ratio sits just below 30. This may seem like a high number; however, it's not that bad when we keep in mind that Monster is an aggressive growth company. I believe that those seeking growth will find a lot of value in this company if they can be patient for at least medium term (two to three years) and put up with high volatility.