Dr Pepper Snapple's Stock Is Stuck

For the truly patient, Dr Pepper Snapple Group Inc. (NYSE: DPS) may turn out to be a bargain within its industry.

Since January 2016, shares have found themselves range-bound, fluctuating in a band of 8 points on either side of $90 per share. During this period, despite plenty of volatility, the beverage company's stock is down roughly 2% -- more or less flat.

Investors' ambivalence stems partly from caution around non-alcoholic beverage companies in general. As consumer tastes have shifted, industry titans like The Coca-Cola Company (NYSE: KO) and PepsiCo, Inc. (NYSE: PEP) have grappled with declining soda volumes, employing diversification strategies to maintain healthy top lines.

Like its competitors, Dr Pepper Snapple is supplementing internal innovation on this front with acquisitions. The company completed its $1.7 billion purchase of antioxidant-enriched bottled water upstart Bai Brands on Jan. 31, 2017.

The deal was a significant one relative to the company's existing asset base of $9.8 billion, and overall, it's been positive for Dr Pepper Snapple. Bai Brands gives the organization an entry point into the burgeoning flavored bottled water market. Bai sales now make up 4.5% of total company revenue. In the second quarter of 2017, Bai contributed $33 million in incremental company gross profit.

Yet projected expenses have perhaps surprised investors. Bai added $40 million in operating expense in the second quarter, with $20 million from planned marketing expense alone. And for the full year, management expects dilution from the acquisition to be around $0.07 per share, as compared to an initial projected impact of $0.02. The revised earnings influence from the deal is likely a significant factor behind the company's continuing range-bound trading pattern.

A purposeful allocation of expense

Much of the additional dilution impact will result from increased customer trial activity for Bai beverages. Management has alighted on initial data which indicates that customers evince a strong tendency to reorder once they've tried Bai at least once. Hence, the company is ramping up discounted and free opportunities for customers to try the both still Bai brands and the carbonated Bai Bubbles lines.

CEO Larry Young described the current and slated 2017 investment activity as follows: "We're currently running trial driving activity in the marketplace at an even greater level than we originally planned as trial rates continue to show improvement, and we want to maximize the opportunity through summer selling season. We will also continue to run some level of activity through the balance of the year."

Even as it pushes into promising flavored water territory, the company has largely escaped a problem that's plagued larger rivals Coca-Cola and PepsiCo -- declining soda volumes. Dr Pepper Snapple's soft drink volume has actually expanded this year. Bottled case volume of carbonated soft drinks (CSDs) increased 3% in the second quarter, following a 1% increase in the first quarter. As a much smaller enterprise than its two fellow soft drink purveyors, the company is better positioned to execute on consumer demand across just a few major soft drinks like Dr Pepper and 7UP.

And yet, since most of its competitors are further along in evolving their portfolios toward healthier drinks, Dr Pepper Snapple doesn't command the same forward multiples of earnings:

The relative undervaluation holds when you consider how industry competitors have structured their balance sheets. Even though Dr Pepper Snapple added roughly $1.2 billion in debt to purchase Bai Brands, it's still cheaper than its peers on an enterprise value-to-EBITDA basis. This measure considers the relationship between total capital structure (i.e., both common stock and debt obligations) and earnings:

Dr Pepper Snapple stock may remain stuck for a while -- and that's OK

The Bai portfolio clearly has potential to lift Dr Pepper Snapple's revenue over the long term. According to the company, independent market research firm IRI has gauged the year-to-date retail sales growth of Bai at 37% across the various channels it measures. But the organization's investment and projected returns will take place over years, not months. In the meantime, now isn't a bad time to snap up a fewDr Pepper Snapple shares. They're fairly stable, and a pay a dividend yielding 2.5%, which you can enjoy while the market warms up to this worthy company.

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Asit Sharma has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Monster Beverage and PepsiCo. The Motley Fool has a disclosure policy.