In a Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP) world it's easy to forget about the number three contender Dr. Pepper Snapple Group (NYSE:DPS). For instance, Coca-Cola and PepsiCo hold about 40% and 30% of the respective American soft drink market share against Dr. Pepper Snapple's 16% allocation. In turn, one could rationally make the argument that Dr. Pepper Snapple doesn't quite have the muscle to take advantage of opportunities in the same way as its much bigger rivals. For that matter, some might indicate that the sugary beverage market is at the beginning of a long decline.
However, I would express caution on both fronts. With regard to Dr. Pepper Snapple lacking the same growth prospects of Coca-Cola and PepsiCo, it should be made clear that the valuation of a business is separate from the operations of that enterprise. More specifically, it might very well be true that both Coca-Cola and PepsiCo will grow faster than Dr. Pepper Snapple moving forward.
In fact, this is precisely what we see as analysts are expecting Coca-Cola to grow at 7.7% and PepsiCo to grow at 8.4% moving forward against Dr. Pepper Snapple's expected long-term growth rate of 6.6%. Yet this alone does not make Coca-Cola or PepsiCo a better investment. What is not readily apparent is that Dr. Pepper Snapple trades at a current price-to-earnings ratio around 15 while Coca-Cola and PepsiCo trade closer to 19. If at some time in the future Coke and PepsiCo's multiple falls slightly or else Dr. Pepper Snapple's ratio expands slightly, the investment playing field is leveled, if not titled, towards Dr. Pepper Snapple's favor. Furthermore, Dr. Pepper Snapple's higher initial dividend yield immediately influences the investing decision.
With regard to the decline in sugary beverage demand, proponents again have a sensible case – especially on the health front. Yet once again, I would express exercising carefulness within one's assumptions. It is true that sugary beverages provide a solid health concern – but that doesn't mean everyone will simultaneously stop drinking them cold turkey. In fact, it would be reasonable to assume that a great portion of soda drinkers will still be downing their sugary delights decades from now.
Further, around the globe – in perhaps less calorie conscious circumstances – there are millions of people entering the middle class. Lastly, it is true that Dr. Pepper Snapple offers the well-known brands like 7-UP, Dr. Pepper, A&W and Sunkist. However, Dr. Pepper Snapple also offers a fantastic array of additional options like Mott's, Snapple, Déjà Blue, Nantucket Nectars and Country Time. In short, health concerns are important – but Dr. Pepper Snapple already offers many of the solutions. In addition, about 75% of the company's volume is generated from brands that are either number one or number two in their category, with 6 of the top 10 non-cola soft drinks under its corporate umbrella.
With this information in mind, let's take a look at the operating history of Dr. Pepper Snapple through the powerful fundamental analyzer software tool of F.A.S.T. Graphs™.
Dr. Pepper Snapple Group was spun off as a stand-alone company in 2008, just before the most recent recession. Despite this inopportune timing, the company has remained strong and profitable. From 2008 until today Dr. Pepper Snapple has grown earnings (orange line) at a compound annual rate of 6% a year. In addition, Dr. Pepper Snapple initiated a dividend (pink line) recently and has been able to grow this payout meaningfully over the last couple of years. Note that the following graphic leaves price off the graph to demonstrate the business behind the stock only. I will add the monthly closing prices to a subsequent graph.
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In viewing the operating results of the company one might expect that the performance results mirror closely with the business results. However, that's not necessarily what we see. Since the spin-off Dr. Pepper Snapple has grown earnings by about 6% a year. Yet performance results were much better. A hypothetical $10,000 investment on 4/30/2008 would have turned into $18,200.28 today, or an 11.1% annualized rate of return as compared to just a 5.9% return of the S&P 500 index.
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The underlying reasoning behind this is relatively straightforward: in 2008 Dr. Pepper Snapple was slightly undervalued and today it appears reasonably priced. Below I have added the price (black line) to the first graph to demonstrate the relationship between earnings and valuation.