Krause Fund Research Spring 2015 Consumer Staples Dr Pepper Snapple Group, Inc. (NYSE: DPS) Recommendation: HOLD April 21, 2015 April Analysts Current Price $77.79 Di Yan Target Price $79.95 [email protected] Leslie Wille DPS Is Worth Waiting! [email protected] Yuqing Fang Dr Pepper Snapple has stable revenue growth each year, [email protected] with an average increase of 2% from 2010-2014. Since the U.S. economy is healthy and experiencing an increasing demand in Company Overview the consumer staple sector due to the growing population nationwide, we expect a 1.27% increase in net sales in 2015. In Dr Pepper Snapple Group, Inc. (NYSE: DPS) is a leading addition, due to volatile commodity prices in recent months, we integrated brand owner, manufacturer, and distributor of non- expect approximately a 1% decrease in the proportion of the cost alcoholic beverages in the United States, Canada, and Mexico. of goods sold in sales in 2015. It is headquartered in Plano, Texas. In 2008, Dr Pepper Snapple Growth for beverage industry has been sluggish in recent was spun off from its parent company Cadbury Schweppes and years, thus we merely estimate a 1.4% continuing value growth started being publicly traded in the U.S. Dr Pepper Snapple has rate for Dr Pepper Snapple after 2019. three business segments including Beverage Concentrates, Since consumers are increasingly concerned about health Packaged Beverages, and Latin America Beverages. The and wellness, they are changing their preferences towards much Packaged Beverages segment has always been the chief healthier drinks. The demand for carbonated soft drinks will revenue producer for the company, which created 71% of decrease as consumers have shifted towards non-carbonated revenues in 2014. beverages such as water, ready-to-drink teas, and sports drinks. Stock Performance Highlights Therefore, if Dr Pepper Snapple cannot effectively anticipate the changes in consumers’ preferences and then quickly develop Market Capitalization $14.85B new products in response, its sales could suffer. In addition, Share Outstanding 192.96M developing and launching new products can be risky and 52 Week Range $52.33 – $81.45 expensive, and some of its competitors may be better able to Beta Value 0.60 respond to these changes, either of which could negatively affect Average Daily Volume 1.03M its business and financial performance.i Key Statistics As environmental issues become more of a concern, the effects that large amounts of plastics and other materials used for Book Value Per Share $11.89 packaged beverages have on it will harm the beverage industry. EPS (ttm) $3.56 Dividend Yield 2.50% 12-Month Stock Performance (S&P 500 in Red) Dividend Payout $1.92 Price/Earnings (ttm) 21.64 Price/Sales (ttm) 2.87 Price/Book (mrq) 12.57 Financial Ratios Return on Assets (ttm) 8.94% Return on Equity (ttm) 30.76% Operation Margin (ttm) 19.25% Current Ratio 1.17 Debt to Equity 1.1 Figuee1: Source: Yahoo! Finance 1 After we analyzed Dr Pepper Snapple by integrating the U.S. economy, the beverage industry, and its company specific performance, we expect a fair value of $79.95 for Dr Pepper Snapple in 2015, which is very similar to the current stock price. Therefore, we recommend holding Dr Pepper Snapple. The U.S. economy is expected to grow and continue to be healthy in the short term. However, since the beverage market in the U.S. is already mature, the sluggish growth of the beverage industry in the U.S. slows down the growth of companies within it. Figure 3: Source: Federal Reserve Bank of St. Louisv Therefore, it is better for Dr Pepper Snapple to seek overseas opportunities, although there are risks associated with such Based on the projections of authority institutions, including the expansion like differences in currency rates and changes in International Monetary Fund, the European Commission, and the governmental policies. Although disposable income is expected Federal Reserve, the Real GDP in 2015 will increase vi to increase, consumer spending has still been soft in recent approximately 3.15%, and 3.06% in 2016. Furthermore, new months.ii Therefore, we suggest that investors can still wait and job openings will give more opportunities to people and boost see how Dr Pepper Snapple reacts to the risks it exposes and how the economy. However, the impact of the federal funds rate it creates its own strategic advantage over other companies. adjustment in 2015 on stocks, along with the economic slowdown in the Eurozone, will also slow down the growth of the U.S. GDP. In addition, the decrease the CCI in January and soft spending in February indicate that people prefer saving more than spending. Therefore, we predict that the Real GDP will increase by 2.6%, as it did in the last quarter of 2014, within the next six months. We also estimate that the Real GDP will Gross Domestic Product increase approximately 3.0% in the next 2-3 years. Real Gross Domestic Product is a vital and commonly used determinant to measure the economic performance of a country. Unemployment Rate The Real GDP is defined as the nominal GDP adjusted by the We think it is an important indicator because unemployment inflation rate that reflects the market value of goods and services rates can reflect the well-being of an economy in a country. For measured annually.iii Since nearly two-thirds of GDP is driven example, during the 2007-2009 recession, the unemployment by individual’s consumption, it is an important indicator of the rate was remarkably high and reached 10% in 2009. consumer staples sector. Alternatively, when an economy stays healthy, it experiences a low unemployment rate. According to the graph below by the Federal Reserve Bank of St. Louis, the U.S. Real GDP has historically remained in an upward As seen in the graph below by the Bureau of Labor Statistics, the trend except during the recessions. unemployment rate gradually recovered to a lower rate after the recession in 2008 and 2009.vii Figure2: Source: Federal Reserve Bank of St. Louisiv Figure 4: Source: Federal Reserve Bank of St. Louisviii Below is a chart showing the percentage change of Real Gross Since 2010, the unemployment rate has continued to decrease by Domestic Product. As seen in the chart, the Real GDP increased an average of 0.1% each year. Additionally, the unemployment by 2.5% on average in 2014, with -2.1%, 4.6%, 5.0%, and 2.2% rate decreased to 5.5% by February this year and held steady at in quarters 1-4 respectively. 5.5% in March. Based on the projections of International 2 Monetary Fund, European Commission, and the Federal Reserve, We believe the CPI for the consumer staples industry will the unemployment rate in 2015 will be approximately 5.6%, and continue to steadily increase by about 2% in the short term, and 5.4% in 2016. ix Referring to the news posted on the Board of by 2.2% in the next two-three years. We believe it will be very Governors of the Federal Reserve System, “labor market similar to the national expected inflation rate because there will conditions have improved further with strong job gains and a only be a small level of growth within the industry. Although an lower unemployment rate.” Hence, we predict that the increase in the minimum wage may cause the CPI to decrease to unemployment rate will probably not change a lot in the short some degree, it will likely be offset by increases in the price of term, it will only decrease by 2%, as compared to 5.8% in the consumer goods. xvi , xvii In conclusion, an increasing CPI will fourth quarter of 2014 since jobless people still need time to find cause consumers to have less confidence in the consumer staples work. In the long term, our group predicts that the industry because they will have less purchasing power. unemployment rate will remain low and stay around 5.5%.x Interest Rate We believe that the low unemployment rate will have positive impacts on consumer staple sectors. Lower unemployment rate The federal funds rate is the interest rate at which banks and can indicate an increase in purchasing power of customers, and other depository institutions lend money to each other. Increasing the federal funds rate will decrease the supply of thus promotes consumer spending. xviii money and increase short-term interest rates, and vice versa. Therefore, the federal funds rate can be seen as a benchmark for Consumer Price Index analyzing interest rates in financial markets. The federal funds The CPI is important for understanding the consumer staples rate has been at a low level of 0.25% for more than 4 years after industry because it reflects changes in price due to rising costs of the 2008 financial crisis. food, beverages, drugs, personal and household items, tobacco, and alcohol.xi The CPI has risen at a relatively steady rate for the last 10 years, due in part to a rise in food and beverage prices. The price of meat, grains, fruits and vegetables, and dairy products have increased in the last several years due to droughts, disease among animals, extremely cold weather, and a citrus greening disease in Florida. In general, the price of all foods and beverages using ingredients from these categories were affected by the calamities. This is due to the fact that the price of products not directly affected rose when more people started to turn to xii cheaper options, thusly causing them to go into higher demand.