Dr. Pepper Earnings Review: Sugary Drinks Continue To Decline In The Domestic Market

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Dr Pepper Snapple ( DPS ) reported a decline of 1% in net sales in the fourth quarter to round up what has been a challenging 2013. As expected , category headwinds in carbonated soft drinks ( CSD ) and juices impacted the company's top line, which was partially offset by a favorable product mix and an increase in Latin America volumes. For the full year, both CSDs and non-carbonated beverages ( NCB ) declined 2% in volumes. Dr Pepper does business only in the Americas, with around three-fourths of its valuation coming from the North America CSD division. As sales of sugary sodas continue to decline in the domestic market, the company has looked to derive meaningful growth from its North America NCB and Latin America divisions. However, the imposed taxes on sugary drinks in Mexico and lack of innovation in NCBs could further reduce Dr. Pepper's revenue in the coming year. The company expects its revenues to remain flat in 2014.

We have a revised price estimate of $48 for Dr Pepper Snapple , which is around 4% lower than the current market price.

See Our Complete Analysis For Dr Pepper Snapple

Dr. Pepper Reaffirms Its Commitment To CSDs Despite Continual Decline

Amid looming health and wellness concerns over consumption of fizzy drinks, sales of Dr. Pepper's North America CSD division decreased by 0.8% year-on-year to around $4.3 billion in 2013 by our estimates. Volumes of the company's Core 4 brands: 7Up, Canada Dry, Sunkist and A&W, including the TEN variants of these drinks fell by 4% in the last quarter over the previous year. Heeding to the call for healthier sugary drinks, Dr. Pepper had launched the TEN lineup of its Core 4 brands last year, following the mild success of Dr. Pepper TEN in 2012. While a 12 ounce bottle of regular Dr. Pepper carries 150 calories, the TEN version provides only 10 calories. However, diet soft drinks were the worst performing segment of the U.S. beverage industry last year mainly due to safety concerns and bitter aftertastes associated with artificial sweeteners, especially aspartame, which is used by most beverage makers including Dr. Pepper.

Despite the discouraging performance of its TEN lineup, Dr. Pepper has announced further investments in marketing and innovation in the hope to revive sales of its diet CSD portfolio in 2014. But as consumers slowly shift from sugary drinks to healthier alternatives such as sports drinks, carbonated water and ready-to-drink tea, volumes for the company's CSD division could further decline. In fact, even the caffeine-fueled energy drinks are taking market share away from CSDs due to their attractive packaging and successful marketing strategy aimed at targeting millennial customers.

However, Dr. Pepper remains hopeful about its diet soda drinks business and plans to launch naturally sweetened 60 calorie versions of some of its brands this year. Although having six times as many calories as the TEN lineup, the company hopes that consumers might prefer naturally sweetened sugary drinks, which still have less than half the calorie count of regular CSDs. In addition, according to a Nielsen Homescan study, 52% of TEN's purchases are to consumers who generally don't drink sugary soft drinks. This means that diet drinks are increasing the overall market size for CSDs, rather than cannibalizing sales of regular soft drinks.

Lack Luster NCB Portfolio Impedes Dr. Pepper's Growth

Dr. Pepper's NCB volumes declined by 2% last year on the back of disappointing performances of its core juice portfolio. Sales of the juice brand Hawaiian Punch fell by 9% in 2013 year-on-year due to lower promotional activities and ongoing criticism of high sugar juices. The company has a small presence is some of the fastest growing segments of the NCB market such as sports drinks, carbonated water and ready-to-drink tea. This could reduce Dr. Pepper's market share in the overall U.S. beverage industry in the future as we expect the NCB segment to constitute about 61% of the domestic beverage market by 2018, up from 56% in 2012.

However, the silver lining for Dr. Pepper is its national distribution agreements with some of the small but faster growing beverage companies. For example, the company has a distribution agreement with Bai 5, a coffee-fruit based low calorie drink, which grew by a whopping 400% to reach $20 million in sales last year. In addition, volumes of Vita Coco, a leading coconut water brand distributed by Dr. Pepper, surged 37% in 2013. Although accounting for a very small portion of the beverage industry presently, sales of coconut water in the U.S. have doubled every year since 2004. Vita Coco crossed a 100 million in sales in 2011, and continues to grow by leveraging Dr. Pepper's scale and efficiency in direct store distribution.

Latin America Provides Growth

With both CSD and NCB sales declining in North America, Dr. Pepper's revenue from Latin America increased by an impressive 11% in 2013, mostly contributed by Mexico. Due to Mexico's large appetite for sugary drinks and bottled water bolstered by the growing middle class and increasing disposable incomes, the company could continue to derive growth from this segment. The country is a major consumer of soft drinks, especially CSDs, with over 146 liters of CSDs consumed per person in 2012. In this respect, Mexico trails only the U.S., which has a massive per capita consumption rate of 165 liters.

However, the Mexican government imposed taxes on sugary drinks late last year in a bid to fight health problems. The country has the world's highest obesity rate of 32.8% apart from a high diabetes rate of 9%. As this levied tax is expected to increase the total cost of goods by 2% this year, Dr. Pepper has raised prices of its sugary drinks in Mexico. Price rise could hamper demand for the company's CSDs in Mexico in the coming year.

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This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: DPS , CSD , NCB , PEP , KO

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