May 27, 2008

Value Idea: Dr Pepper- Part 2

Part 2 can viewed here. In this post i will review some of the risks associated with DPS.

Declining US Soft Drink Volumes

Soda volume in the US is declining due to health conscious consumers. However, the domestic soda's woes largely are a cola problem affecting Pepsi and Coke more than DPS. The flavored segment in which DPS competes is still healthy. Hispanics, one of the fastest-growing segments of the U.S. population, tend to favor flavored sodas. Moreover the fruit-based drinks account for about one-fifth of DPS's revenues and posted growth of 5% last year.

The company brands are performing well in the flavoured segments. The company's leading brand, Dr Pepper, is one of the industry's best, with volume increasing an average of about 2% annually in recent years. Although Snapple, which has been tossed from one corporate parent to another, but has never quite lived up to its lofty expectation, DPS has managed to revive the brand -- the No. 3 iced tea behind Pepsi's Lipton and privately held Arizona. Snapple's sales volume rose about 7% last year, and could maintain that pace. Snapple is popular in the New York area and California. DPS is building a new Southern California plant to serve the West Coast, ending the need to truck in Snapple from the Northeast.

However, some of its brands past history is less than stellar. Dr Pepper's attempt to enter the sports-drink market with a Gatorade-like drink, Accelerade, flopped, costing it about $55 million last year. Dr. Pepper, for instance, was a pioneer in cherry-flavored cola, but now faces stiff competition from Cherry Coke, while Coca-Cola's Sprite long ago vanquished 7Up despite the latter's head start in the lemon-lime category.

Leveraged Balance Sheet

The company has a substantial but manageable load according to most safety ratios. Their debt level compared to their free cash flows is very manageable. The company now have a higher debt to equity ratio which is not a bad thing for me as it leverages the opportunity.

International growth limitations

The company does not have international distribution or sales profile. Actually there are severe limitations to achieve any results on this front. DPS has sold many of its well known brands to Coke for international markets. The company mainly operates in Canada, US and Mexico.

Quality of the financials

  • no benefit plan obligations liability and the assumptions of the plan are reasonable with LTM expected return of 5.5%.
  • Cash flow from operations growth matches earnings growth and close in absolute figures.
  • inventory growth matches sales growth trends there are no apparent channel stuffing.
  • Accounting policies do no seem aggressive


This one will be difficult to assess for a new standalone company. However, the stability of its market-share over the years as noted earlier and improvements in the performance of some of the lagers brands like Snapple, reflect positively on management capability.

The compensation plans have not been set yet. I get a suspicion that management is waiting for a decline in its stock price so options and stock awards will be set a lower price. That is a possibility and not a negative one for me. Although outright ownership of common stocks is negligible, to the tune of .01%, I will be looking for insiders compensation once revealed to ensure they are properly aligned with shareholders interest.

In part 3 I will review my valuation and rationale for purchasing DPS.


Jim said...

I own DPS.
Mgt is getting some options and SAR's issued to them. exercise price is $25.36. Lots of form 4's filed May 9.
For instance see

Sami said...

thanks, I looked at all the statement 4 but I was also referring to the official compensation policy and how compensation is set for executives. In the initial registration statement they do not outline it rather they outline Cadbury's policies.

Like I said it is not really a negative since like you said they have a bunch of options and new CEO bought a whopping 100 shares in stock, so you got insider buying as well :)