SodaStream Pops

Summary

• Q4 capped off an excellent year for SODA.
• Sales of sparkling water makers accelerated to their highest rate of growth in four years.
• Despite the shift in sales mix from higher-margin consumables to soda machines, margins improved significantly.
• The decision to consolidate manufacturing and logistics activities into a single facility has materially improved the margin profile.

SodaStream International (NASDAQ:SODA) is the world's largest and best-known maker of home beverage carbonation systems, with an estimated user base of 12.5 million households. The SodaStream device carbonates water by adding CO2 from a pressurized cylinder to create sparkling water in seconds. The company also sells more than 100 types of concentrated syrups and flavorings to make carbonated drinks.

SODA went public on the Nasdaq in November 2010 and has a strong track record of growth and margin expansion (Figure 1). The company uses a "razor/razor blade" business model, which is designed to increase sales of sparkling water systems (the razor) and to generate recurring sales of higher-margin consumables, consisting of CO2 refills, flavors, and carbonation bottles (collectively, the razor blades). The beauty of this strategy is that increased sales of sparkling water systems result in subsequent increases in gross margin associated with higher sales of consumables.

Figure 1: Key Operating Metrics

Source: Madison Investment Research

Historically, the growth in revenues was driven by a heightened focus on promoting sparkling water makers, particularly in North America (the world's largest market for carbonated beverages) and Western Europe. As the installed base of sparkling water makers increased in these markets, it resulted in even stronger growth in consumables revenues over time (Figure 1). In more recent times, an increasing portion of the growth has come from sales in less mature markets in the Asia Pacific, Central & Eastern Europe, the Middle East, and Africa.

Strength Continues

SODA reported its results for Q4 and FY17 a couple of weeks ago and the results were better than expected. Sales of sparkling water makers increased 26% for the quarter, consumables sales grew 14%, and EBITDA was up 24%. Western Europe was particularly strong, accounting for more than half the revenue increase, which indicates that there's still a long runway for growth in the company's largest (albeit more mature) markets. SODA's marketing and distribution strategies are clearly paying off, resulting in higher household penetration and increased usage of home carbonation systems.

But perhaps even more impressive than the growth in revenue was that margins expanded more than 300 bps, despite a sales mix that was heavily skewed toward lower-margin beverage makers than consumables compared to recent years (Figure 1). Margins did receive a boost due to currency, but the increase largely reflects the benefits from consolidating SODA's manufacturing and logistics activities into a single state-of-the-art facility, which has resulted in cost savings and better product margins.

SODA reported record net income in 2017, and the decision to consolidate has materially improved SODA's margin profile: Investors can expect normalized adjusted EBITDA margins in the mid-upper teens going forward, compared to the low-teen margins SODA was generating between 2010 and 2015.

Looking forward, management expects revenues to increase ~ 12% in FY18. Approximately 2% is expected to result from the recent acquisition of the company's French distributor (an acquisition that should help SODA compete more effectively with Perrier in France where it has struggled); but the rest will be organic - from a mix of growth in the installed based and higher consumable sales (management expects the sales mix to stay relatively constant at 40% soda makers and 60% consumables in FY18). This would mark the third consecutive year of double-digit top line growth.

Operating income is expected to increase 10% (20% if you exclude the expected increase in stock-based compensation in H1 '18), and diluted EPS is expected to grow 5% to $3.29 (15% excluding the impact of stock options). The implied margin expansion (excluding stock options) reflects continued benefits from manufacturing consolidation and forward integration. However, investors should not simply dismiss the higher stock-based compensation, as the dilution it causes is a real cost to shareholders.

Conclusion

Q4 capped off another great year for SodaStream. Sales of sparkling water makers, the fundamental driver of SODA's business, accelerated to their highest rate of growth in 4 years, and the company is realizing more of the cost and pricing synergies that come with large-scale consolidation. All signs point to a continuation in these trends in 2018, and we think investors have a lot to look forward to the future.

SODA is expensive. The stock is up 70% in the past year vs. 23% for the consumer discretionary sector (XLY), and currently trades at twice its 5-year average as a multiple of cash flow. Traders looking to make a quick profit shouldn't expect too much out of this stock, but we think SODA is an interesting choice for buy-and-hold investors.

Even though soda consumption is on the decline in the developed world, there's still a lot of growth left in SODA's core markets and the company is also growing its footprint in emerging economies. Also, SODA's machines aren't used exclusively for soda. Customers can choose among a wide range of beverage options, and the company has emphasized healthier drinks over the years such as zero-calorie fruit drops and waters.

Analyst’s 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.