How Dr Pepper Snapple Can Rebound in 2018

MarketsMotley Fool

Non-alcoholic beverage companies have rebounded this year against a flat showing in 2016. But to the consternation of shareholders of Dr Pepper Snapple Group, Inc. (NYSE: DPS), its stock has lagged its peer group year to date. You'd expect high-flying National Beverage Corp. and Monster Beverage Corp. to greatly outpace more conservatively positioned Dr Pepper Snapple. But larger competitors The Coca-Cola Company (NYSE: KO) and PepsiCo, Inc. (NYSE: PEP) have also enjoyed better gains on a total-return basis:

Why the relative malaise? Skepticism over the company's $1.7 billion acquisition of Bai Brands LLC, which closed on Jan. 31 of this year, is the primary factor compressing share trajectory.

Continue Reading Below

At the time of acquisition, management provided guidance that Bai Brands would add two percentage points to the company's targeted 2017 revenue growth of 4.5%. While Dr Pepper Snapple is standing by the revenue growth rate, as of the third quarter of 2017, it now projects Bai will contribute just one percentage point to that total.

There are a few reasons behind a slower projected growth rate for Bai. For one, under founder and former CEO Ben Weiss, the company's expansion leaned on volume from purchasing clubs like Costco Wholesale and Wal-Mart Stores' Sam's Club.

Packaging for clubs in bulk doesn't promote the healthiest growth, as a beverage becomes perceived -- and sold -- as a commodity. The current team managing Bai products is pushing for retail grocery shelf space, where more individualized sales (as opposed to by the case) will lead to greater sampling and trial purchases of the drinks. Pulling back a bit from club revenue hits near-term expansion, but it's a more sustainable strategy.

Overoptimism from management regarding the initial impact of Bai also played a role in revised expectations. Investors can quibble with an inaccurate forecast, but in truth this was an atypically large acquisition for Dr Pepper Snapple. In retrospect, management probably wishes it had issued a slightly more circumspect projection this spring.

It wasn't just revenue that the company misgauged. Originally, the transaction was projected to dilute earnings per share by just $0.02, but during the year, management decided to invest more heavily in Bai sampling and promotion. An additional $20 million in marketing spend is one of the factors now pushing Bai to a projected 2017 dilution to EPS of $0.11.

Nonetheless, the brand still has more than credible long-term potential. As Dr Pepper Snapple CEO Larry Young pointed out on the most recent earnings conference call, Bai has quickly become a leader in the enhanced-water category, and as measured by third-party research company IRI, its growth last quarter in retail channels exceeded 50%.

Setting expectations

As I argued when the Bai deal was announced, aside from the obvious benefit of diversifying away from carbonated-soda volume, the purchase of a company like Bai turns contracted distribution into more profitable "in-house revenue," and eases the vulnerability Dr Pepper Snapple has to its "allied brands." These are brands for which Dr Pepper Snapple merely functions as a distributor, and they're prone to being snared by competing distribution systems at the end of contractual periods, or even being acquired by the company's competitors.

All factors considered, the farther out you gaze, the better Bai's potential looks. But to restore shareholder confidence in the near term, management needs to more accurately project both the top- and bottom-line impacts of Bai on the overall business when the company issues full-year 2018 guidance in February.

It's not necessary for Dr Pepper Snapple to show a tremendous profit from Bai next year. But a logical roadmap for investment, sales growth, and bottom-line contribution, accompanied by tidier numbers, could restore waning enthusiasm. Like it or not, this acquisition has become a focal point for shareholders.

The good news for those contemplating picking up Dr Pepper Snapple stock is the market's current discount on shares. In August I highlighted the company's undervaluation relative to competitors, using its ratios of forward price to earnings, and enterprise value to EBITDA (earnings before interest, taxes, depreciation, and amortization).

That's still true today, and in fact, the company looks cheaper than its rivals on additional fronts. To the initial two metrics, we can add the price-to-sales ratio:

...and even price-to-book value:

Clarity on the 2018 plan for Bai Brands could restore some premium cachet to a formerly popular stock in the non-alcoholic beverage space. And further acquisitions using the Bai model, if on a more modest scale, may reward those buying the stock at a discount today.

10 stocks we like better than Dr. Pepper Snapple GroupWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Dr. Pepper Snapple Group wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of December 4, 2017

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