Energy Drinks, Bottled Water On Tap For Soda Giants

S oda. Pop. Coke. No matter what people call them, soft drinks have steadily been seeping out of the American diet for the past decade or so, as superfoods and salads replace hamburgers and fries. Carbonated soft drinks -- referred to as CSDs in the industry -- have fallen in overall volume by 16.7% between 2003 and 2014, according to Wells Fargo, as consumers guzzle bottled water and energy drinks in their stead.

Larger portions of thirsty and free-spending younger consumers have gravitated to energy drinks -- soda-like, stronger-than-coffee energy-boosting concoctions. They have been a hot ticket forMonster Beverage ( MNST ). Since acquiringCoca-Cola 's ( KO ) energy brands -- including Full Throttle, NOS and others -- Monster has become the U.S. energy drink market leader with 42% dollar share, Cowen & Co. analyst Vivien Azer told IBD.

In June, the two companies closed a deal in which Monster scooped up Coca-Cola's energy drink portfolio and Coca-Cola acquired Monster's non-energy brands plus a 16.7% stake in Monster.

"Monster has done a great job of building (its energy drink) business," said Wells Fargo analyst Bonnie Herzog, adding that there is "huge upside" for the company, though much of it is already priced into the stock.

Shares of Monster have climbed 37% since the start of the year, and the company has logged earnings growth in nine out of the last 10 reported quarters, most recently topping Q3 estimates. This growth helped it earn an IBD Composite Rating of 97, which means that it has outperformed 97% of publicly traded companies based on a combination of technical and fundamental factors.

Potential Growth Abroad

Analysts say that the company's growth potential lies abroad in its battle to catch up with global leader Red Bull. Monster received a big leg up in that fight through its distribution deal with Coca-Cola, which made it a preferred global distribution partner in 28 countries. Monster said in November that it plans to enter the China market in the first half of next year.

There's a "good energy (drink) market" in China, said Morningstar analyst Adam Fleck. "Given Monster's branding, (it'll) probably help to create pretty sizable growth for them going forward." China's energy-drink market is growing at a high-teens rate, according to Stifel estimates, vs. the U.S.' high-single-digit rate.

Domestically, energy drinks have logged a 23.2% compound annual growth rate ( CAGR ) in 2003-2014 and still have plenty of room for growth, say analysts. By contrast, soft drinks have a negative 1.6% CAGR over the last decade or so, according to Wells Fargo, drawing upon data from Beverage Digest.

"Although the addressable energy drink market is probably smaller than that of broader sodas, we believe the category's growth can continue to outpace traditional carbonated soft drinks," wrote Morningstar's Fleck in a Nov. 6 note. He pointed to low U.S. per capita consumption of energy drinks compared with other types of beverages. He projects that Monster will grow internationally at a clip of more than 20%, while domestic sales growth sticks to the low double digits.

Even diet sodas have lost popularity, largely due to concerns over artificial sweeteners. Soft drink volumes are declining faster than the overall carbonated soft drink category, said Herzog.

Monster Under The Microscope

So why aren't energy drinks -- which are packed with just as much sugar as cola -- subject to the same health-conscious scrutiny that have weighed negatively on soft drinks?

Energy drinks are extremely popular among young adults, particularly males, who are "probably less impacted by calorie and sugar concerns" than other consumers, said Fleck via email.

"Moreover, the consumption rates of energy drinks are still quite low compared to mainstream CSDs on a per-capita consumption rate, leaving room for people to enter the category," he wrote.

For sports drinks, Fleck says that having the calories is actually important and that the calories in a drink like Gatorade, for instance, are roughly half that of traditional CSDs.

But Fleck does note "some movement" into diet energy and sports drinks, highlightingPepsiCo 's ( PEP ) diet Gatorade product, G2, and Monster's Ultra Zero, which is the company's second-bestselling product behind its original energy drink.

Bottled Water Everywhere

Consumption of bottled water has also benefited immensely from shifting consumer tastes. Even plain old tap water has grabbed market share at the expense of soft drinks, said Fleck.

In 2014, bottled water led gains in the nonalcoholic drink market. Of the major brands tracked by Beverage Digest, Nestle Pure Life volume grew 8.9%, Coca-Cola's Dasani rose 8.2%, Nestle's Poland Spring climbed 7.9%, and PepsiCo's Aquafina rose 7%. By comparison, Coke and Pepsi volumes fell 2.4% and 2.9%, respectively.

In its most recently reported quarter, Coca-Cola said that its "still" or non-carbonated beverage portfolio -- which includes water, juice and tea -- grew 6% globally by case volume, led by 11% growth in packaged water. Sparkling beverages rose only 2%, with an 8% Diet Coke decline weighing on results.

"Everything outside of soda is doing better for them, and that's been true for a while now," said Cowen's Azer of the company.

Coca-Cola and PepsiCo together have only about 13% U.S. volume share of the bottled water space, according to Wells Fargo, while Switzerland-basedNestle ( NSRGY ) dominates with almost half of the market. But don't expect the soda heavyweights to try to vie for Nestle's No. 1 position.

"Bottled water has driven the majority of incremental growth in beverage volumes, but the category has the lowest average price per case with low margins too, making the category relatively unattractive to manufacturers," wrote Herzog in a November note on the beverage and tobacco sectors.

Instead, Coke and Pepsi are working on making gains in the "value-add" water category, said Fleck, which includes products like flavored sparkling water and vitamin-enhanced H2O.

"(Coke and Pepsi will) probably grow more slowly in the category but won't be giving up as much margin," he said.

Soft drinks make up about three-quarters of Coca-Cola's U.S. business, which means that the company is more exposed to CSD trends than, say, PepsiCo. Fleck says that Pepsi gets two-thirds of its profits from its snack business. Soda makes up 80% ofDr Pepper Snapple Group 's (DPS) business, though it occupies a slightly different space from Coke and Pepsi. It has no exposure to colas, but a strong presence in niche-flavored soft drinks such as Canada Dry and 7UP.

Coca-Cola, Monster and Dr Pepper are members of IBD's Beverages-Nonalcoholic industry group, which ranks fourth out of IBD's 197 ranked groups. Smaller memberNational Beverage (FIZZ), which makes LaCroix sparkling water and Faygo, among other products, has a 98 Composite Rating, on par with Monster.

Old Coke In New Bottles

As consumers lean toward beverages with healthier images, where does that leave traditional soft drinks? Are carbonated sodas on the brink of fizzling out?

Not quite, say experts. Soft drinks still made up well over half of all retail beverage sales last year.

At the same time, the experts don't expect the current downward trajectory of CSDs to stop anytime soon.

Coca-Cola has transitioned its strategy in recent years and is in the midst of refranchising its bottling operations, though it retains minority stakes in many of its bottlers. The move is seen boosting profitability.

In August, Western Europe'sCoca-Cola Enterprises (CCE), Coca-Cola Iberian Partners and Coca-Cola Erfrischungsgetränke AG of Germany announced a three-way merger, becoming the largest independent Coca-Cola bottler. Under the agreement, Coca-Cola will own 18% of the newly combined company, which will be called Coca-Cola European Partners.

And Coca-Cola, PepsiCo and other soda makers plan to recapture the beverage market with the same old product, albeit in slightly different packaging -- think smaller cans that appeal to health-conscious individuals who still crave an occasional fizzy drink.

In turn, consumers wind up paying more per ounce, which analysts call out as a positive.

"(There's a) long runway ahead for smaller package sizes," said Fleck.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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