Jones Soda: The Long Case, and a Threat to Coke and Pepsi

Includes: JSDA, KO, PEP, PUSH
by: Shailesh Kumar

Recent articles in Barron's and The Wall Street Journal by Christopher C. Williams suggest that Jones Soda (NASDAQ:JSDA) is overvalued based on its historical revenues and earnings and that the stock will consequently underperform in the future. According to the author, "the stock has lost its fizz".

The basis for Mr. Williams' case lies in the following observations:

1. Jones Soda Company's trailing PE is 146 and its PE based on 2007 earnings estimate is 112.

2. Jones missed analysts estimates for Q1 earnings by a large margin.

3. Jones has shown very slow revenue growth in the past and the historical performance does not warrant a high PE.

4. Jones is a cult soda brand and will remain a cult brand and will never become a mass-produced or mass-available brand to pose any threat to Coke (NYSE:KO) or Pepsi (NYSE:PEP).

It appears that Mr. Williams has done great research on the ratios and historical data for Jones but I believe he has misunderstood the story behind this stock.

It therefore makes sense to review the long case for Jones Soda. 2007 has been the year of expansion and growth for Jones Soda, triggered by a significant change in the business strategy. The company decided to shift its focus from a 500 MM premium bottled drinks category to a 66 B canned beverage category. This change in management focus is accompanied by a host of strategic initiatives, including:

  • A distribution deal with National Beverage Corp. (FIZ) for up to 35 m cases (of cans) per year (Jones supplies concentrate; National Beverage produces the cans and distributes nationally to retail stores).
  • Agreements with national retail stores including Safeway (NYSE:SWY), Albertsons, Walmart (NYSE:WMT), Kroger (NYSE:KR), Target (NYSE:TGT), Publix (OTC:PUSH), etc to begin carrying Jones products in their stores with cans being the main focus. This increases Jones' availability from the last year's 2% retail outlets to an estimate of 25% retail outlets by the end of 2007 and 50% by the end of 2008. The company's experiences in April, along with channel checks at the retail stores, indicate that the sell-through is tending to be much better than originally estimated.
  • Recent agreements with Ruby Tuesday (NYSE:RT) with the possibility of more restaurants to come. Ruby Tuesday now prominently offers Jones Sodas in their restaurants.
  • Jones Soda recently upstaged Coke and got the exclusive rights to sell their sodas at the Seahawks stadium in Seattle. Jones is the only soda company other than Coke or Pepsi to have an exclusive deal with an NFL team. This deal involves fountain drinks and water as well as several flavors including a cola flavor that is especially being developed for launch on July 7 2007. At a recent blind taste test conducted for the Seattle Seahawks, Jones Cola was preferred 3 times out of 5 over either Coke or Pepsi.
  • Jones Soda is in the process of launching a national advertisement campaign involving TV, radio and print.
  • The above facts call into question the assertion that Jones Soda is destined to remain a cult brand. The Seahawks deal suggests that the Coke and Pepsi duopoly has just been seriously challenged. Sports teams in both the NFL and other leagues have also called on Jones Soda for similar deals. Mass distribution pacts via retail, restaurants and sports venues, along with ad campaigns, will put Jones Soda prominently in front of the consuming public.

    Sadly, all the above, while critical to Jones' story and the reason to invest in its stock, were missing from the Barrons and WSJ article.

    Let's review Jones' valuation:

  • Mr. Williams reports that Jones will earn an estimated 17 cents per share in 2007, based on the estimates released by the few sell side analysts who cover the stock. Note that this estimate essentially says that there will be no improvement in Jones Soda earnings in 2007 over 2006, despite 1200% increase in retail availability of Jones Soda, 2-5% improvement in gross margins, additional products (water) and new flavors (Cola, pomegranate, etc), and a national ad campaign.

    The sell side analysts have no way of modeling how the new enhanced water product (24C) will sell, so, they do not model it. However, if the recent 4.2B acquisition of Glaceau by Coke is any indication, this product is definitely worth something.

  • On a very high level, Jones believes that sometime by the end of this year or early next year the 35 MM case capacity at National Beverage may become inadequate and therefore it will need to find additional capacity. Given that channel checks show the sell-though to be better than estimated, it would be conservative to believe that by the end of 2007, Jones will be running at a run rate of 26m case/year. There is a 50 cent profit for Jones for each case net of all the expenses, which means a run rate of $0.50 EPS on just cans. The Bottle business will add another $0.10 (if you assume some cannibalization with cans). Contribution from Water is difficult to estimate, but note that even a market share of 1% that of Glaceau (VitaminWater) could add about 10% to the valuation of Jones.
  • So to summarize, at the end of 2007 Jones' annual EPS run rate is more than $0.60 EPS at about 25% ACV ("all commodity volume" -- ie. with distribution in 25% of potential outlets).

    In 2008, we will be looking forward to a 100% increase in ACV for cans, a large increase in the water business and possible international expansion; therefore, a growth rate of more than 100%. If on Dec 31st you were to calculate a fair value for Jones Soda, what value would that be? Using that value for Dec 31st, how much would you be willing to pay for Jones Soda today?

    My fair value for Jones Soda today is more than $40. The more than 22% shorts in this stock are also wrong. Every growth stock has a fair value based on its prospects and Jones Soda's value will be realized soon enough.

    Disclosure: Author has a long position in JSDA

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