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DR. PEPPER SNAPPLE GROUP, Inc. (NYSE: DPS) Krause Fund Research | Fall 2015 Consumer Staples DR. PEPPER SNAPPLE GROUP, Inc. (NYSE: DPS) Recommendation: HOLD November 13, 2015 ANALYSTS Zach Digmann Jun Ho Kang [email protected] [email protected] Current Price: $86.86 Paul Landherr Maddison Wignall [email protected] [email protected] Target Price: $94.44 COMPANY OVERVIEW Cash Returns Focus for Declining Dr Pepper Snapple Group, Inc. (DPS) is a long time leading brand owner, manufacturer, and distributor Beverage Market of non-alcoholic beverages within the beverage • DPS has committed to returning cash to industry. Dr Pepper Snapple Group's product lines investors by increasing dividends and are divided in to two main categories: flavored continuing to repurchase stock. We estimate that carbonated soft drinks (“CSDs”) and non-carbonated DPS will continue to repurchase $400M worth beverages (“NCBs”). DPS operates in three primary of stock per year. business segments: Beverage concentrates, Packaged • DPS operates in the beverage industry which is Beverages and Latin America Beverages. For the fiscal year ended 12/31/14, total revenues rose 2.07% in a mature declining state. To combat declining to $6,121 million. US sales DPS has invested in Latin America to pursue new growth opportunities. STOCK PERFORMANCE HIGHLIGHTS • The industry DPS operates in is going through 52 Week High: $90.95 changes due to consumer preference shifting 52 Week Low: $69.39 towards healthier alternatives as well as new Avg. 5-Year Weekly Beta: 0.704 regulation for unhealthy food and drink. Avg. Daily Volume: 1,268,190 • DPS operates only in the US, Canada and Latin America making their operations localized only SHARE HIGHLIGHTS in North America. This represents a geographic Market Capitalization: $16.41 b risk and doesn’t allow worldwide risk Shares Outstanding: 192.96 m diversification opportunities. Book Value/Share: $11.62 EPS: $3.77 YEAR STOCK PERFORMANCE 1-Year Forward P/E: 20.33 Yield: 2.6% Payout Ratio: 50.9% COMPANY PERFORMANCE HIGHLIGHTS ROA: 8.53% ROE: 30.76% Source: MSN Money Sales: $6,121 m 1 ECONOMIC OUTLOOK Unemployment: We believe there are five main macroeconomic Unemployment has an impact similar to that of GDP forces that affect the consumer staples sector. These on the consumer staples sector. While it may not drivers are gross domestic product, unemployment, have a direct impact, the consequences of inflation, consumer sentiment, and demographic unemployment can affect what products are shifts. purchased. As evidenced previously, it appears that when more people are laid off and without work as Gross Domestic Product: during the recession, consumers shift to private label Gross domestic product (GDP) is an indicator of the brands as a way to conserve money. As the economy overall health of the economy. In the third quarter, as improved, less private label goods were purchased. a percent change from the second quarter, U.S. GDP Unemployment is currently at 5.0%.[4] The previous grew at a seasonally adjusted 1.5%.[1] The consumer month also had dramatically higher job creation than staples sector is non-cyclical by definition. However, predicted at 271,000 jobs.[4] As shown in the graph we contend that the more robust the economy is, the below, unemployment has steadily been decreasing more consumers are willing to purchase name brand since 2010. A positive side effect of this decline is products over private label competitors. Since the that it can put upward pressure on wages. Average end of 2009 to the end of 2012, the number of people hourly earnings increased 0.4% over the previous purchasing private label products fell more than month as more became employed.[4] This association 10%.[2] This fact is particularly important as we are provides an explanation for the reason as to why analyzing DPS which is a name brand in the name brand goods are purchased more often in a beverage industry. solid economy with strong employment. Higher wages allow consumers to feel as though they are in After the economy recovered from the recession, a secure financial position, giving the incentive to GDP has remained relatively strong in the past five purchase name brand goods over the cheaper private years with minor contractions in the first quarters of label rivals. We expect the unemployment situation 2011 and 2014, as shown in the graph below. As to stay the same in the near term at 5.0%. We see consumers drive around two-thirds of the economy,[3] unemployment dropping slightly to 4.7% in 2-3 we expect the economy to get a slight boost at the years as the economy improves more, but not more close of the year with increased production for the than a slight decrease to stay around the natural rate holiday season. However, with the recent slowdown of unemployment. in Chinese growth, in six months we see GDP growing at 2.5%. In 2-3 years, we believe the U.S. economy will be on solid footing with steady employment and stronger oil prices giving rise to 3.3% long-term growth. Source: Bloomberg Inflation: The Consumer Price Index (CPI) is a measure of the change in the average price level of a fixed basket of Source: Bloomberg goods and services purchased by consumers.[5] This 2 key gauge of inflation has been persistently low in recent months due to low energy costs and low costs of imports, driven by the strength of the dollar. The last reported monthly change was -0.2%.[5] If the Core CPI is used (meaning food and energy prices are excluded), there was a 0.2% increase month- over-month.[5] In six months, we see a monthly change in the CPI of 0.2%. In 2-3 years when oil prices recover and with lower unemployment, we predict an annual inflation rate of 2.7%. Source: Bloomberg The CPI matters to consumers because if prices are Consumer Sentiment: increasing at a rate faster than wages are increasing, The University of Michigan’s Consumer Survey shifts in product purchasing may be needed. Center questions 500 households each month on their Additionally, to look at the effect of inflation on the financial conditions and attitudes about the consumer staples sector, it is interesting to compare economy.[6] For November, consumer sentiment is the CPI to the Producer Price Index (PPI). By sitting at 93.1.[6] January 1996 is the base period comparing the graphs below, it is possible to see cost where consumer sentiment is 100. Thus, we believe increases that firms are absorbing that cannot be this is a strong reading for the current consumer passed along to consumers. With the exception of the outlook driven by strength in the job market and most recent year, the CPI appears to be much more stock market returns. Since the recession, as shown volatile than the PPI. Furthermore, it appears that in the graph below, consumer sentiment has risen producers are able to pass price increases along from poor readings in the 50s level.[7] As discussed reasonably well. When the PPI is increasing, so is the previously, consumers drive a majority of GDP CPI by an equal amount. This relationship would growth and consumer sentiment is directly related to suggest that producers are able to shift price changes the strength of consumer spending. Therefore, we see along to consumers more often than not, allowing this strong consumer sentiment number as a good them to avoid cost absorption. sign for the future economy. In the near term, we believe consumer sentiment will be at 94.5 based on rising wages. In 2-3 years, after GDP expands at a faster rate and inflation remains relatively normal, we believe consumer sentiment will measure 98. Source: Bloomberg 3 Demographics: exclusively in the beverage retail business, some Demographic shifts in the U.S. population will drive companies, such as Pepsi, also have more diverse the types of products purchased in the consumer holdings and include some food product lines. staples sector in the future. The U.S. population is aging, as evidenced by U.S. Census data. In 2002, the The industry has faced push backs over recent years percent of the population between 20 and 44 years due to people’s desire to be healthier. A common place for consumers to begin improving their health old was 36.3%.[8] By 2012, this percent of the has been eliminating high calorie drinks from their population had decreased to 33.4%.[9] This diets. As revenue declines, businesses will have to information shows that the United States population start relying on higher margins and diversification to is currently aging, as Baby Boomers enter the remain profitable. In recent years, the decline in oil postretirement stage. Soon, as this part of the and energy prices have allowed margins to increase population phases out, what will remain is a large, from decrease in transportation costs. Corn prices are younger population. This change will drive also a large input cost of sodas in the industry due to consumer demands in the coming future. In the the use of corn syrup as the primary sweetener. beverage products industry of the consumer staples sector specifically, you see this showing up in demands for healthier drinks. This suggests that in order to satisfy consumer demands, companies will need to begin to shift their product lines to meet expectations. Costs could increase as a result, but by getting ahead early and developing innovative products, companies could establish a competitive advantage in new products. INDUSTRY ANALYSIS: BEVERAGES Industry Description: Companies like Coca-Cola and PepsiCo have tried to The beverages industry consists of numerous increase revenues through sales in emerging markets, products which could be categorized into carbonated especially in Brazil, Russia, India and China.
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