Finding Tasty Beverage Stocks

Includes: DPS, KO, KOF, MNST, PEP
by: Ahmed Jabril

The market for non-alcoholic beverages is extremely crowded in developed markets. Moreover, the global footprint of many beverage products means that new frontiers are scarce and that sales growth will be tempered by competition. What's worse, investors seeking to find attractive investments among non-alcoholic beverages are hard-pressed to find companies trading at low price multiples in today's market.

As a result, investors have to be very picky when choosing beverage stocks.

Big Sodas Going Flat

PepsiCo (NYSE:PEP) reported a 5% drop in net income year-over-year for the third quarter. PepsiCo's snacks business grew sales by 3%, outpacing its beverages business which grew by 1%. Despite a 3% increase in prices, PepsiCo's American beverage sales in the third quarter dropped by 5.3%. This is not a soft-drink growth story.

Somewhat better, Coca-Cola (NYSE:KO) experienced modest growth during the same period. The third quarter saw the global sales volume of Coca-Cola increase by 4%. Two percent of this increase was attributable to growth in the North American market. The company also enjoyed a 1% increase in Europe region income profits in its third quarter.

Neither Coca-Cola nor PepsiCo trades at compelling valuations. Coca-Cola currently trades at a high 19.21 price-to-earnings ratio and a high 3.49 price-to-sales ratio. a higher value than the 14.23 and 1.32 average multiples for the S&P 500 index. Pepsico's 1.61 price-to-sales ratio is closer to market averages but its 18.24 price-to-earnings ratio is still high. Neither company is trading at low enough valuations to make them buy targets in light of tepid growth.

More reasonable valuations are found in Dr Pepper Snapple Group (NYSE:DPS) stock. The firm's 1.5 price-to-sales ratio and 15.27 price-to-earnings ratio are closer to S&P 500 averages than either Coca-Cola or Pepsi. It is also a reasonable dividend stock candidate based on its 3.19% dividend yield and sustainable 0.47 payout ratio. These price multiples better reflect slow growth prospects.

Finding Growth

Not all brands are as old as Coke and Pepsi. Many newer brands have more opportunity for growth in developed markets. Monster Energy (NASDAQ:MNST) is a prime example of a company which has been able to grow a brand within developed and highly competitive markets.

Unfortunately, the valuations of Monster are too high for prudent investors. Monster shares currently trade at a 4.19 price-to-sales ratio and a 24.8 price-to-earnings ratio. These are very high mulitples that do not reflect the damage that could come from bad press.

Monster's valuations remain high even after its shares plunged when the survivors of a deceased girl filed a lawsuit against the company. The family of 14 year-old Anais Fouriner sued Monster Energy in California Superior Court alleging that the Company failed to warn consumers of possible dangers associated with the consumption of their product. The New York Times reported that the FDA was investigating five deaths that may be linked to the Company's energy drink.

Red Bull has also faced this type of negative publicity. Red Bull was banned in France in the 90s due to possible health risks. Red Bull, however, was able to reverse this decision and was re-approved in France in 2004.

More interesting beverage growth opportunities may exist in smaller stocks. Premier Brands [BRND - OTCBB] is a California-based manufacturer of beverages and nutraceuticals. It sells vitamin drink and energy products to convenience stores, pharmacies, and supermarkets. Its brands include Zizzazz Energy Mix, Zizzazz Extreme Fitness Formula, Kidzazz Kids Vitamins, Zizzazz Vitamins, and Make ME Vitamin C. The company has recently signed brands like People Water to marketing and distribution agreements and is partnering with Peoples' Juice & Tea Corporation to develop new product lines. Premier Brands currently has a very small market capitalization of about $20 million but is an interesting speculative bet that should be thought of as late stage venture capital.

Turbulence in Developing Markets

There is more growth in soft drinks overseas, but there is also more volatility. As an example, consider Coca-Cola Femsa (NYSE:KOF). Its third quarter results look excellent but it seemed in dire straits based on second quarter results. This stock is a wild ride.

Coca-Cola Femsa's third quarter results with revenues grew 20.3% year-over-year in third quarter 2012. Their improved operating margins accelerated operating income at a rate of 26.6%. During a third quarter earnings event conference call, Chief Executive Officer Carlos Salazar Lomelin stated: "After facing a very tough commodity and volatile currency environment over the past several quarters, we look forward to a strong close of the year."

When you take a look at their second quarter net income however, one sees a completely different picture. Analysts had estimated a 2.96 billion peso profit ($200 million) but the reported profits were 2.71 billion pesos ($198 million). Coca-Cola Femsa was further derailed by the weakening peso which slid by 12% against the dollar. Net income fell by 9% with the cost of labor and freight increasing in Argentina and Venezuela which pushed these expenses up by about 38%.

This volatility and growth will probably continue for Coca-Cola Femsa as it expands beyond Latin America with a business unit in the Philippines. Unfortunately, investors should avoid this stock at current price levels which anticipate extreme growth. High growth expectations are clearly priced into KOF shares at a 2.45 price-to-sales ratio and a rich 29.58 price-to-earnings ratio.

Soda Valuations

Investors need to exercise patience in the face of high valuations. Many non-alcoholic beverage giants are trading at fair to high valuations, not compelling ones. Investors interested in an income investment may consider Dr Pepper Snapple Group. Investors may also consider lesser-known companies like Premier Brands as speculative growth plays. However, value investors should shy away from larger, established firms trading at fancy price multiples.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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