Will Alkaline Water Company Finally Overcome Its Acidic Past?

| About: Alkaline Water (WTER)

Summary

Alkaline Water Company reported strong sales growth for March and positive financial expectations for the current quarter.

The company is riding a trend away from acidic beverages toward those high in pH.

The past and recent dilution of investors has left a bad taste with the market.

The recent retail agreements could finally reward shareholders as the company is on pace to reach cash flow neutral.

After years of fits and starts, Alkaline Water Company (OTCQB:WTER) is finally making some great headwinds into the growth phase despite missing original targets. The stock remains a high risk with lots of skepticism in the market, but a unique opportunity exists.

Source: Alkaline Water presentation

The company is riding a trend in the preference for consuming water over soda and the preference to move away from acidic beverages towards products high in pH. Some skepticism exists regarding the touted benefits of alkaline water, but it doesn't matter to investors why consumers follow a trend. The only thing important is whether Alkaline Water is positioned to ride a trend to higher sales and future positive cash flows.

Corporate Profile

The small-cap stock sells the Alkaline88 bottled water product to retail outlets in the U.S. Recent deals include distribution agreements with Costco (NASDAQ:COST) in the Pacific NorthWest and Albertsons (NYSE:ABS)-affiliated Tom Thumbs in the greater Dallas/Ft. Worth region. These deals are on top of numerous other deals to sell its bottled water to well-known retailers.

Alkaline Water Company focuses on a proprietary electrolysis process that produces water with alkaline properties by coating electronic cells with rare earth minerals to produce scientifically engineered water. The water has an 8.8 pH balance that contrasts with the highly acidic soda beverages produced by the likes of Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP). The high alkaline water supposedly destroys pepsin that when activated by acid causes the reflux symptoms.

The company has had a dilutive past highlighted by previous Seeking Alpha articles, while at the same time, the alkaline water bottler has recently generated exceptional revenue growth. The only problem is that the inability to meet internal growth targets could again force future dilutive moves.

Beverage Industry Outlook

The beverage industry growth path is definitely favoring a shift toward healthier beverages. Anybody following Coca-Cola or Pepsi knows that soda consumption has pressured those companies over the last decade or so and pushed the beverage giants into non-soda investments.

According to research from Beverage Marketing, the U.S. liquid refreshment beverage market grew quicker in 2015 due in large part to bottled water segment growth. The healthy, natural and zero-calorie concepts are highly desirable by consumers that continue to shed traditional soda beverages like Coke, Pepsi and Mountain Dew.

Worth noting, the water brands of Nestle Pure Life, Poland Spring, Dasani, and Aquafina are all top 10 beverage trademarks. All four water products saw the leading growth last year for the top trademarks, with only the sports drink trademark of Gatorade approaching the growth rates of bottled water.

While the water bottlers are showing the fastest growth, the volumes are still relatively small compared to soda products. Coke products alone sold nearly 4.0 million gallons in 2015. The top water trademarks together were only 80% of the Coke consumption at 3.2 million gallons. When factoring in all the top 10 trademarks, water accounted for only 23% of the gallons consumed.

According to RBC Capital Markets (via Business Insider), soda consumption has seen a dramatic decline in consumption since the peak back in 1998.

While soda consumption continues collapsing, Marketing Daily highlights a report from Mintel showing that bottled water sales are expected to continue growing through 2020. The market reached $15 billion in 2015 and should grow roughly 35% to over $20 billion by 2020.

Even more interesting is that the sparkling and mineral water segment is forecast to surge 75% in that time period. Consumers listed the below favored attributes when consuming bottled water:

  • 43% - enhanced with vitamins
  • 29% - contain minerals
  • 29% - energy enhancers added

Celebrity Endorsements

So, clearly the data supports the position that bottled water consumption is gaining market share over soda during the next five years. The market generally understands that market shift, but the interesting move is some of the celebrity endorsements of alkaline and a lower acidic diet. Such celebrity plugs could generate momentum in the area whether justified or not.

Interestingly, both Kate Hudson and Elle Macpherson recently made statements supportive of this general shift in the market.

... your body becomes acidic. When you start to become more alkaline, it's just basically healthier. Everything digests better, your blood is (at a proper pH balance) - Kate Hudson via Fox News

I believe that most ailments come from having an acidic body - Elle Macpherson via People

Neither of these celebrities are pushing Alkaline Water per se, but the company does have Brande Roderick of Baywatch fame plugging the product as the Brand Ambassador for Alkaline88.

Maybe even more importantly, celebrities like Mark Wahlberg and Sean Combs are investing in Aqua Hydrate by The Yucaipa Companies. This bottled water brand focuses on raising alkalinity to a pH of 9 and adding electrolytes and natural trace minerals to fuel performance and hydration.

Of course, having celebrities push the general concept or the specific product aren't guarantees of success. Though, it does hint that Alkaline Water is onto a concept that could become mainstream. A mainstream product has the potential to significantly reward shareholders.

Recent Progress

While not making the original target for reaching $10 million in annual sales for FY16, Alkaline Water is making progress in ramping up growth. The company recently released that revenue for the month of March actually topped $1 million with record purchase orders of $1.14 million. In essence, the company has annualized sales exceeding $12 million.

The company suggests that financing now exists to fund growth that includes targets of reaching $18 million in sales this fiscal year ending in March 2017. This forecast suggests growth ramping to 150% YoY from the 89%-plus growth rate achieved last year.

Even more importantly, the target includes reaching cash flow neutral for the current quarter that ends in June. If Alkaline Water wants to remove the fears of the past dilutive history, the biggest step is getting to cash flow neutral and eliminating the need to raise equity in the future.

According to the company, the recent expansion in the Phoenix plant provides for the bottling of roughly $4 million in shipments each month. Of course, the bright side is that this level allows for a nearly doubling of the revenue forecast for the current fiscal year. On the flip side, a company running below 50% of capacity typically struggles to generate profits.

Alkaline Water forecasts being in 30,000 stores by next April, suggesting sales of roughly $600 per store at the $18 million target. The real question is whether the company can generate a profit on what amounts to sales of only one to two small bottles per day at each store.

For the December quarter, the company had a $890,000 operating loss after originally forecasting a cash flow neutral quarter along with the goal of hitting $10 million in FY16 revenue. A crucial part of the investment story is meeting the updated projections for reaching the all-important cash flow neutral two quarters later. Another mis-step by any significant amount most likely would crush shareholders.

Dilution Prospects

The whole Alkaline Water story sounds good until getting to the financial position and the big issue of the past. The company has limited cash and needs to actually hit the cash flow neutral phase or future stock offerings are needed.

Back in March, Alkaline Water sold 9.0 million shares to raise $2.97 million. The offering was completed at an incredibly low $0.33 per share and even included one-half of one warrant to purchase one share at $0.50 over the next two years. The exercise of the warrants would add another $2.25 million in cash.

The company planned to use the money to repay loans totaling $1.5 million and the remaining cash to further develop operations.

For the December quarter, Alkaline Water listed 3 million shares outstanding following a 50-for-one reverse stock split completed on December 30. After the incredible dilution of the offering in March, the company listed 14.7 million shares outstanding. Considering the shares now trade for roughly $1.50, the stock has a market value of over $20 million.

With more cash flow presumably burned in the March quarter, the expectation would be a cash balance around $1 million. Though presumably, Alkaline Water would have an ability to re-borrow the $1.5 million or even more, considering the financial prospects of the company appear more promising now.

Huge Risks

Investing in Alkaline Water is a huge risk considering the small-cap nature, limited cash balance, and lack of profits or positive cash flow. Not to mention, the company is not out of the woods regarding future stock dilutions even if financial targets are met.

Though the data and research supports the direction of the company toward water bottling with alkaline properties, the company is a small water bottler. According to a Nielsen report referenced by Alkaline Water, the Alkaline88 product is the 18th largest seller in the Southern California market. To be fair, the product is the second fastest grower for the 12 months of the report through the end of November, but the share is only 0.4%.

Even a successful concept could become over shadowed by a bigger company such as Coca-Cola, Pepsi or any of the other bottle water producers in SoCal alone. Or even, the smaller Aqua Hydrate supported by Marky Mark and P. Diddy could leapfrog the leading position in the Alkaline market by Alkaline88.

Ultimately, though, the risk is typical of a fast-growing stock with limited finances or market position. At the expected growth rates, the stock is appealing at a valuation of only $20 million, but the risks are significant. Any loss of key retail customers or the inability to turn profitable could lead to a total financial loss for investors.

Under the best case scenario, Alkaline Water Company is able to utilize improved financials over the course of the summer to raise more funding at higher stock prices. After all, the prime reason listed for missing the original FY16 financial targets was a lack of sufficient capital.

Takeaway

Alkaline Water Company is interestingly positioned in the growing bottled water market to grab the shift away from acidic beverages like soda. The positioning provides a unique head start for the company, though any number of existing large beverage companies could easily surpass the initial success of the Alkaline88 product with a reasonably small investment.

Solid execution and continued expansion by Alkaline Water could significantly reward investors at this low valuation. The stock easily trades at multiples of the current valuation if the $18 million sales goal is met with further growth forecasted for FY18.

Naturally, any investment is only appropriate for a diversified portfolio where investors are willing to lose the investment.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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