Dr Pepper Snapple Group, Inc. - University of Oregon Investment

June 3 , 2 01 1
Co nsumer Sta ples
!
!
Dr Pepper Snapple
Group, Inc.
!
RECOMMENDATION: HOLD
!!
Stock Data
Price (52 weeks)
Symbol/Exchange
!
Beta
!
Shares Outstanding
Average daily volume
!
Current market cap
!
!
!
Current Price
Dividend
Dividend Yield
33.60-42.44
DPS / NYSE
0.9129
226.30 million
2.038 million
$9.28 billion
Two-Year Share Price and Trading Volume:
$40.99
$0.25 per share
2.40%
!
Valuation (per share)
!
DCF Analysis
Comparables Analysis
!
Target Price
Current Price
!
Summary Financials
!
Revenue
Net Income
Operating Cash Flow
$43.35
$73.93
$43.35
$40.99
!
2010A
$5.636 billion
$528 million
$163.65 million
!
!
!
!
!
Covering Analyst: Jack Roeder
Email: [email protected]
The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational.
Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be.
Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG’s portfolio. In
addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG’s portfolio.
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
BUSINESS OVERVIEW
Dr Pepper Snapple Group, Inc. (DPS) is an integrated beverage brand owner, manufacturer, and distributor of
non-alcoholic beverages in the U.S. (89% of sales), Canada (4% of sales), and Mexico and the Caribbean (7% of
sales). DPS was spun off from Cadbury Schweppes on May 5, 2008, and began trading on the NYSE on May 7,
2008. Headquartered in Plano, Texas, Dr Pepper Snapple Group, Inc. is a leading provider of flavored carbonated
soft drinks (CSDs) and non-carbonated beverages (NCBs). They have built their success through strategically
acquiring beverage brands and then building them into leaders in their category. Examples of these key brands
include:
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
!
The firm’s operations are divided into three key segments: Beverage Concentrates, Packaged Beverages, and
Latin America Beverages.
Beverage Concentrates – 21.12% of 2010 revenue ($1.2 billion)
The Beverage Concentrates segment is generally operated as a brand ownership business. After manufacture,
beverage concentrates are shipped to first and third party bottlers and distributors, where they are combined with
carbonation, water, sweeteners, and other ingredients. They are then bottled in plastic or aluminum and shipped to
retailers. Beverage concentrates can also be manufactured into syrup, which is sold to fountain customers who
mix the syrup with carbonated water to produce a finished beverage. PepsiCo and Coca-Cola are the largest
customers of the Beverage Concentrates segment, representing 30% and 21% of the segment’s net sales in 2010,
respectively.
Historical Performance:
Net Sales
Segment Operating Profit
Segments Operating Margin
2008
983
622
63.28%
2009
1,063
683
64.25%
2010
1,156
745
64.45%
Packaged Beverages – 72.16% of 2010 revenues ($4.1 billion)
The Packaged Beverages segment manufactures finished beverages from beverage concentrates and distributes
them across the U.S. and Canada. This segment manufactures both first and third party brands and distributes
them through first party channels or third party distributors. Final retail locations include supermarkets, mass
merchandisers, vending machines, convenience stores, gas stations, and grocery stores. Due to bottling and
distribution, this segment is sensitive to changes in aluminum, plastic, and oil prices.
Historical Performance:
Net Sales
Segment Operating Profit
Segments Operating Margin
2008
4,305
483
11.22%
2009
4,111
573
13.94%
2010
4,098
536
13.08%
2
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
Latin America Beverages – 6.72% of 2010 revenues ($382 million)
The Latin America Beverages segment has similar functions to the Beverage Concentrates and Packaged
Beverages segments with operations focused in Mexico and the Caribbean. This includes the manufacture,
bottling, and distribution of first and third party beverage brands. Key brands in this segment include Peñafiel,
Squirt, and Clamato. Low operating profit in 2010 is largely due to considerable investments in information
technology infrastructure and marketing.
Historical Performance:
Net Sales
Segment Operating Profit
Segments Operating Margin
2008
422
86
20.38%
2009
357
54
15.13%
2010
382
40
10.47%
BUSINESS AND GROWTH STRATEGIES
Dr Pepper Snapple Group, Inc. outlines six key elements to their overall business strategy:
• Build and enhance leading brands – DPS spends a great deal of time identifying the brands that have the
greatest potential for profitable growth, and then invests heavily in innovating and developing these
brands to match consumer preferences.
• Focus on opportunities in high growth and high margin categories – The most recent trend in the liquid
refreshment beverage (LRB) industry is the emergence of alternative beverages such as flavored waters
and energy drinks. These beverages tend to be healthier than traditional soft drinks and/or provide a
functional benefit such as caffeine or taurine.
• Increase presence in high margin channels and packages – High margin retail locations include
convenience stores, vending machines, and independent retail outlets. Volume in these channels is
expected to grow as the economy recovers, consumer confidence increases, and people have more
discretionary income. DPS is taking advantage of this by investing in branded coolers and other cold
drink equipment specific to their well-known brands. High margin packages tend to be smaller serving
sizes and single-serve packages, which DPS plans to increase demand for through heavy promotional
activity.
• Leverage our integrated business model – The LRB industry experiences strong benefits from economies
of scope and through vertical integration. Dr Pepper Snapple’s brands cover a wide variety of beverage
segments, and their integrated business model allows them to align the economic goals of their business
as a whole.
• Strengthen our route-to-market – Recently, this has involved heavy investments in information
technology infrastructure, especially in Mexico and the Caribbean. Additionally, DPS has developed
systems for third party bottlers and distributors to help maintain priority for their brands in other
companies’ systems.
• Improve operating efficiency – The major component of this strategy is Dr Pepper Snapple’s recent Rapid
Continuous Improvement (RCI) initiative that they began in 2010. This initiative involves the
development of Lean business practices and Six Sigma efficiencies throughout the company.
The majority of the company’s focus seems to be on building and enhancing their leading brands and improving
operating efficiency. As the US economy recovers from the recession and people have more discretionary income,
they will begin returning to the brands they are familiar with and loyal to. DPS plans to take advantage of this
through heavy advertising and investments in current brands and product lines. For example, they plan to launch
the new beverage Dr Pepper 10, a low calorie soft drink for men, nationwide in 2011. Additionally, after DPS was
spun off from Cadbury Schweppes in 2008, management’s focus was on transitioning into a standalone beverage
3
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
business. Now that the transition is largely complete, management can focus more time and resources toward
improving Dr Pepper Snapple’s operations. This is evident in their recent RCI initiative, which has already
produced promising results.
One major concern with DPS’s growth strategy is their lack of focus on the alternative and functional beverage
markets. These markets have seen strong growth as consumer preferences shift away from unhealthy CSDs
toward healthier options. However, DPS continues to focus the majority of their resources on existing and new
carbonated soft drinks. In fact, during their 2010 annual earnings call, when asked whether or not DPS plans to
participate more actively in non-carbonated beverage categories, President and CEO Larry Young responded:
“No, we’re still very happy with our portfolio… we stay focused on the total portfolio, but we are putting
a lot of emphasis right now on our carbonated soft drinks. As I mentioned a moment ago, I think with the
tough economic times we’re going to see people come back in and recognize that value. That’s where
we’re putting a strong focus.”
I feel that this lack of consideration for the strength of emerging product categories will be a missed growth
opportunity for Dr Pepper Snapple going forward.
Finally, a key point to note is Dr Pepper Snapple’s relatively low international exposure. They currently only
operate in the US, Canada, and Mexico and the Caribbean. This presents a significant growth opportunity into
international markets. However, since DPS has not indicated any intention of international expansion, I did not
consider it in my quantitative valuations.
MANAGEMENT AND EMPLOYEE RELATIONS
Larry D, Young – President and CEO 2007-Present
Martin M. Ellen!"!CFO 2010-Present
Larry Young was appointed to CEO and President of
DPS in 2007 after leading the spinoff from Cadbury
Schweppes. He has approximately 30 years of
experience in the beverage industry, beginning as a
worker on a route truck and working his way up. His
30-year career includes 25 years in the PepsiCo family
of businesses. Including his role as CEO of DPS, he
also serves on the company’s Board of Directors.
Martin Ellen has over 25 years of broad experience as a
financial officer in a wide variety of industries. Before
joining DPS, Martin Ellen was the CFO at Whitman
Corporation, which then owned Pepsi Cola General
Bottlers, Inc. He is not on the company’s Board of
Directors
4
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
PORTFOLIO HISTORY
•
•
Tall Firs:
o Purchased 600 shares on 10/8/2009 at a cost basis of $17,580. This holding is currently worth
$24,864, representing a return of 41.43%.
Svigals’:
o Purchased 68 shares on 10/2/2009 at a cost basis of $1,926.43. This holding is currently worth
$2,792.08, representing a return of 44.94%.
RECENT NEWS
April 27, 2011 – Dr Pepper beats, keeps view despite cost spikes (Reuters.com)
DPS beat earnings earnings estimates for Q1 2011. However, they did not increase their outlook for the rest of the
year. Some analysts interpret this as a sign of slower growth going forward. However, others viewed it as a sign
of strength as commodity prices are expected to rise significantly in the coming years.
April 29, 2011 – Consumer Sentiment in U.S. Increased in April on Jobs (Bloomberg.com)
Signs of job growth are finally starting to boost consumer confidence. With more jobs and recovering consumer
sentiment, firms whose sales depend on discretionary purchases, such as DPS, are expected to benefit.
May 11, 2011 – Dr Pepper Snapple Group Stock Hits New 52-Week High (TheStreet.com)
As of May 11, 2011, DPS began trading at a new 52-week high, and has recently begun trading at an all-time high
around $42 per share. These figures have been seen as both attractive and troublesome to different investors.
May 16, 2011 - Dr Pepper files trademarks for more low-cal sodas (MarketWatch.com)
Following the success of Dr Pepper 10 in its test markets earlier this year, Dr Pepper has filed trademarks for
Canada Dry 10, Seven Up 10, and A&W 10. DPS has not stated any definite plans to launch these products, but
this signals their intention to compete more heavily in the healthier, lower calorie drink markets.
INDUSTRY
The liquid refreshment beverage (LRB) industry as a whole is experiencing growth that is mostly in line with the
growth of the economy. Since DPS has product offerings in most of the categories within the LRB industry, a
breakdown by sub-industry is helpful.
Syrup & Flavoring Production
The syrup and flavoring production industry is a roughly $6.5 billion per year industry. It includes companies that
produce and sell beverage concentrates that are eventually used in the production of bottled beverages or fountain
drinks. This industry is clearly at the end of its maturity stage and entering the decline stage as revenue is growing
slower than the economy. As consumer preferences shift
toward healthier alternatives, industry players have been
required to adapt their product offerings.
Profitability in this industry is highly dependent on sugar and
corn prices, as these comprise a huge majority of input costs.
Sugar and corn prices are expected to increase in the coming
years and place pressure on margins. Consequently, firms with
5
!
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
strong brand names and pricing power will be able to manage their margins and maintain profitability.
Since syrups and concentrates have to be turned into finished beverages before being sold to the end consumer,
the demand for this industry is dependent on the demand for carbonated soft drinks, juices, and other beverages.
As a result, the syrup and flavoring production industry has seen an overall decline of around 5.5% in the last five
years due to lower levels of discretionary income and shifts in consumer tastes away from unhealthy beverages. It
is expected that the industry will grow slowly over the next five years as discretionary income recovers with the
economy and alternative and functional beverages grow.
Carbonated Soft Drink Production
The carbonated soft drink consumption industry is a roughly $17.0 billion per year industry. It includes firms that
turn syrups and concentrates into finished beverages, bottle them, and then distribute them for resale. Like the
syrup and flavoring production industry, this industry is entering its decline stage, as consumers prefer healthier
alternatives. Over the past five years, the industry has declined roughly 7.1%, and the industry is expected to
decline roughly 2.0% per year over the next five years. The key driver of this industry is per capita soft drink
consumption, which has declined consistently over the past decade, and is projected to continue declining in the
future.
Although the industry is expected to decline, it is highly concentrated with key players who will likely be able to
maintain profitability through their strong brand offerings and pricing power. These major players are able to
make strategic acquisitions of alternative beverage brands that they can sell at a premium. The major players in
this industry are Coca-Cola (43.7%), PepsiCo (35.4%), and Dr Pepper Snapple (15.0%).
!
Vertical integration is a key trend in this industry. Both The Coca-Cola Company and PepsiCo, Inc. have acquired
all or a majority share of their respective bottling and distribution companies. This trend is a result of pressured
margins and the goal of integrated beverage firms to operate their entire supply chain as profitably as possible.
Fruit Juice and Functional Beverage Production
The fruit juice and functional beverage production industry is a roughly $27.0 billion per year industry and
includes fruit juice, functional drinks, ready-to-drink coffee and teas, and flavored water manufacturers. This
industry has experienced impressive growth over the past five years, and is expected to continue growing but at a
slower rate going forward. This growth is largely driven by increased health consciousness and busier lifestyles
that benefit from functional beverages.
6
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
PepsiCo, Inc., The Coca-Cola Company, and Dr Pepper Snapple Group, Inc. are the major players in this industry
with market shares of 35.0%, 18.5%, and 6.4%, respectively. This market concentration grants these firms strong
brand recognition and pricing power.
Similar to the carbonated soft drink industry, the success of the fruit juice and functional beverage industry is
largely dependent on discretionary income. As consumer sentiment increases, this industry is likely to experience
growth. However, it is possible that consumer curiosity concerning functional beverages has been exhausted. This
suggests that people will begin turning toward the brands they are most familiar with, placing much greater
importance on individual brand advertising in this industry.
As an integrated beverage company, Dr Pepper Snapple must face the changing landscape of the liquid
refreshment beverage industry. Consumer preference and income drive this industry. Consequently, increasing
disposable income and a greater demand for healthy and functional beverages present DPS with considerable
opportunities going forward.
S.W.O.T. ANALYSIS
•
•
•
•
•
•
•
•
Strengths
Strong, recognizable beverage brands in a
number of markets (most brands are #1 or #2 in
their product category)
Management team with a wealth of experience
in the LRB industry
Separation from Cadbury Schweppes allows
continued ability to focus resources on their
beverage business
Strong relationships with key customers
Integrated business model allows for alignment
of company goals at multiple levels of
operations
Opportunities
Increasingly health conscious consumers
demand alternative and functional beverage
options
The recovering economy suggests people with
have more discretionary income, leading to
more impulse purchases at convenience store
and grocery outlets
Relatively limited international presence leaves
room for considerable expansion abroad
•
•
•
•
•
Weaknesses
Continued focus on carbonated soft drinks
rather than alternative and functional beverages
Considerably smaller in size than their two
major competitors Coca-Cola and PepsiCo
Lack of international exposure
Threats
Margins could be hurt by rising and volatile
commodity prices
Unforeseen changes in consumer preferences
PORTER’S 5 FORCES ANALYSIS
Supplier Power - High
Supplier power for Dr Pepper Snapple is high. Almost all of Dr Pepper Snapple’s inputs are commodities such as
sugar, corn, PET, fuel, aluminum, apple juice concentrate, and natural gas. As a result, DPS has very little power
7
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
in affecting the prices they pay for these commodities. They do have some hedges in place to protect against large
fluctuations in commodity markets, but they still have little control over the prices they ultimately end up paying.
Barriers to Entry - High
Barriers to entry are relatively high since brand recognition is incredibly important. Additionally, larger firms
experience significant benefits from economies of scope and scale, making it difficult for new entrants to match
their operational efficiencies. Independent brands are able to find success in niche and local markets.
Buyer Power – Low to Medium
Depending on their buyer, buyer power can range from low to medium. The Coca-Cola Company and PepsiCo,
Inc. represent roughly 50% of Dr Pepper Snapple’s beverage concentrates segment and are considerably larger in
size than DPS. However, these relationships are contractual so few changes can be made. Beyond this, other
buyers of Dr Pepper Snapple’s products have low power because they represent a small fraction of Dr Pepper
Snapple’s sales and Dr Pepper Snapple’s strong brand names grant them pricing power in most markets.
Threat of Substitutes – Medium to High
The threat of substitutes is medium to high. Consumers that are health conscious or with preferences that are not
met by Dr Pepper Snapple’s product offerings may seek to fill their beverage needs elsewhere since switching
costs are incredibly low. However, since integrated beverage producers experience large benefits from economies
of scope, all major players in the industry offer a very wide range of beverage options.
Degree of Rivalry – Very High
With only three major players in the integrated beverage industry, the degree of rivalry is very high. The CocaCola Company, PepsiCo, Inc., and The Dr Pepper Snapple Group, Inc. all offer products in every major nonalcoholic beverage category that directly compete with one another. They offer superior brands with pricing
power that have developed loyal customers. Since brand loyalty plays such an important role in this industry,
major players compete on brand image rather than price, making marketing and advertising very important
aspects of these three companies.
COMPARABLES ANALYSIS
In conducting a comparables analysis for Dr Pepper Snapple Group, I focused on companies in the liquid
refreshment beverage industry that had operations in manufacturing, bottling, and distribution. It was difficult to
find companies with the same combination of strong brands, diversified product offerings, relatively small size,
and integrated business model as Dr Pepper Snapple, so I chose companies that balanced these elements.
Ultimately, I placed a greater weight on a diversified portfolio of strong brands because this is Dr Pepper
Snapple’s key strength and the growth element that they stress the most.
The multiples I chose to use are EV/Revenue, EV/Gross Profit, EV/EBITDA, EV/(EBITDA-CapEx) because they
provide an overall picture of how well a firm can generate revenue, manage margins, and generate sustainable
cash flow without worrying about differences in accounting standards.
The Coca-Cola Company (KO) – 35%
The Coca-Cola Company (KO) is the world’s largest non-alcoholic
beverage company. Key brands include Coca-Cola, Diet Coke,
Sprite, Fanta, and Mr. Pibb. In October of 2010, KO acquired the US
operations of their main bottler and distributor, Coca-Cola
Enterprises, Inc. (CCE) in order to maximize the efficiency of their
! operations as a whole. Additional brands and companies that KO has
8
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
acquired include Glaceau (makers of Vitamin Water and SmartWater), FUZE, Dasani, Powerade, Honest Teas,
and Full Throttle.
I chose to weight The Coca-Cola Company at 35% because they are the nearest company to being a pure-play
competitor with Dr Pepper Snapple. They have very strong brands in all major non-alcoholic beverage category,
they focus on expanding their existing brands whenever possible, and look to acquire alternative beverage brands
in order to compete in those markets and achieve greater economics of scope. Additionally, DPS has a distribution
agreement with KO, meaning that KO distributes some Dr Pepper Snapple brands throughout the US and Canada.
The key differences between The Coca-Cola company and Dr Pepper Snapple are that they are much larger in size
and they have much more international exposure.
PepsiCo, Inc. (PEP) – 35%
Similar to The Coca-Cola Company, PepsiCo, Inc. is a world leader in
branding, manufacturing, bottling, and distributing non-alcoholic
beverages around the world. Key brands include Pepsi, Diet Pepsi,
Mountain Dew, and Sierra Mist. PepsiCo, Inc. also acquired their two
! main bottlers and distributors the Pepsi Bottling Group (PGB) and
PepsiAmericas (PAS) in order to strengthen their supply chain and streamline their route to market. Additional
brands and acquisitions include Aquafina, Gatorade, and Tropicana.
I chose to weight PepsiCo, Inc. at 35% because they compete with Dr Pepper Snapple in ever major non-alcoholic
beverage segment with strong brands and their beverage operations have a closer size to DPS than KO’s. In spite
of this similarity in size for beverage operations, PepsiCo, Inc. also operates heavily in the lower margin snack
food market with their Quaker and FritoLay brands, in which DPS has no presence.
Hansen Natural Corporation (HANS) – 20%
Hansen Natural Corporation (HANS) markets, sells, and distributes
“alternative” beverages in a number of beverage categories. These brands
include Hansen’s Natural Sodas, Hansen’s Fruit Juices, Monster Energy
Drinks, Java Monster, and Peace Teas.
I chose to weight Hansen Natural Corporation at 20% because they are a
smaller sized beverage brand owner, they have limited international
!
exposure, and they strongly represent the growth opportunities in
alternative beverages. They are not weighted more because they do not have the same brand recognition in
carbonated soft drinks and they are not as heavily integrated as Dr Pepper Snapple.
National Beverage Corp. (FIZZ) – 10%
National Beverage Corp. is an integrated developer, manufacturer, marketer,
and distributor a wide variety of non-alcoholic beverage products throughout
the United States. Their two key brands are the Shasta and Faygo soda brands,
which they offer in over 50 flavor varieties. Additional beverage brands
include Everfresh, LaCroix, Crystal Bay, and ClearFruit.
I chose to weight FIZZ at 10% because they have similar geographic
distribution and they are also an integrated non-alcoholic beverage provider.
!
!
9
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
However, they are much smaller in size and scope than DPS and have much weaker brand strength.
My comparables analysis resulted in a large undervaluation. It is unclear exactly what is causing this price
discrepancy, but it is possibly due to the huge acquisitions made The Coca-Cola Company and PepsiCo, Inc. in
2010 that drastically changed the structure of these two firms. Additionally, it is difficult to make an accurate
comparables analysis in this industry due to the extremely high market concentration. It would be impossible to
do a comparables analysis of Dr Pepper Snapple, Inc. without including KO and PEP, but they are fundamentally
different firms in size, scope, product offerings, growth opportunities, and global exposure. Hansen’s and
National Beverage Corp. have similar geographic coverage to Dr Pepper Snapple, but they do not have the same
level of brand equity and product offerings. As a result, I decided to weight my comparables analysis at 0% in my
final valuation for Dr Pepper Snapple, Inc.
DISCOUNTED CASH FLOW ANALYSIS
Revenue
Looking forward, I see DPS growing their revenue through a combination of greater sales volume and price
increases. This will largely be a function of growing consumer confidence and greater discretionary income. As a
result, I see DPS growing in line with management guidance of around 3-5% for 2011. I stayed on the
conservative end of estimates because price increases from earlier in the year are not likely to continue increasing,
and planned product rollouts have unproven results. Beyond 2011, I trended revenue growth down because I feel
that Dr Pepper Snapple’s continued focus on carbonated soft drinks and North American markets will cause them
to suffer lower levels of growth.
Beverage Concentrates
The beverage concentrates segment’s performance directly depends on downstream demand from the packaged
beverage segments. However, I project stronger growth from this segment because of its exposure to fountain
beverages. As the economy recovers, consumers not only spend more discretionary income at grocers and
convenience stores, but at restaurants, as well. This will lead to increased growth in this segment. I then project
this segment’s revenue to trend downward because of Dr Pepper Snapple’s focus on unhealthy soft drinks and
lack of international expansion.
Packaged Beverages
Increased consumer confidence and discretionary income will lead them to make more purchases at convenience
stores, grocery stores, and vending machines. This will greatly help this segment. However, again, DPS’s focus
on unhealthy beverages will dampen this segments growth in the longer term. As a result, I project conservative
growth for this segment that slowly trends downward.
Latin America Beverages
Although the Latin America segment experienced declining revenue from 2008 to 2009, a solid first quarter in
2011, successful information technology investments, and strong plans for advertising to the Latin American
market led me to project growth in this segment for 2011. I then trended this growth downward over the next 10
year in line with my other revenue projections.
Cost of Revenue
For Dr Pepper Snapple, cost of revenue is almost entirely comprised of PET, diesel fuel, corn (for high fructose
corn syrup), aluminum, sucrose, and natural gas. Prices for these inputs are largely determined by commodities
markets and are greatly affected by changes in energy and oil prices. Since prices for oil and energy are expected
to rise in future years, I projected that cost of revenue will increase nominally every year. Management guidance
predicts cost of revenue will increase between 6 and 7% for year end 2011. I trended cost of revenue up as a
10
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
percent of revenue through 2014 and then trended it downward to slightly above historic levels because Dr Pepper
Snapple’s pricing power will allow them to manage their gross margin going forward.
Selling, General & Administrative Expenses
I project that SG&A will decrease as a percent of revenue through 2013 because management’s recent Rapid
Continuous Improvement (RCI) initiative to become more operationally efficient has been successful recently. I
project that this will allow them to decrease SG&A as a percent of revenue to levels below historical averages.
However, management has stated that benefits received from the RCI initiative will be used on increased
marketing for their key brands. As a result, SG&A only decreases as a percent of revenue to slightly less than
historical averages (35%) and then flattens out through the terminal year.
Depreciation and Amortization
I kept depreciation and amortization constant as a percent of revenue at 2.25%. This is in line with historical
values and I do not predict any major changes going forward.
Tax Rate
Management guidance predicted a tax rate of around 35% for the rest of 2011. Since this rate is consistent with
previous tax rates, I kept the tax rate at 35% through the terminal year.
Net Working Capital
Since Dr Pepper Snapple is an established firm with a large quantity of similar customers and suppliers, I decided
to keep accounts receivable as a constant percent of revenues and accounts payable as constant percent of cost of
revenues in line with previous years.
DPS received a large cash payment from their recent licensing deals with The Coca-Cola Company and PepsiCo,
Inc. I decided to trend this cash amount down toward normal levels until 2017.
Capital Expenditures
Management expects to incur annual capital expenditures around 4.5% of revenues on purchases of replacement
equipment, system upgrades, and expansions to the distribution fleet.
Acquisitions
Acquisitions allow firms in the beverage industry to maintain revenue growth through the addition of new brands
to a firm’s portfolio and extended geographic distribution coverage. Since management has not explicitly stated
any plans to make an acquisition in the near future and has stressed their focus on current brands, I did not project
any acquisitions in the next three years. However, I do project that Dr Pepper Snapple will make two acquisitions
within the next ten years. To consider this in my valuation, I looked at the medium-sized acquisition of FUZE
Healthy Infusions by The Coca-Cola Company in 2007, which was approximately $225 million. I multiplied this
value by two, and then divided that amount between the years of 2014E through 2020E, with the later years
weighted heavier because I believe that DPS has a greater probability of making acquisitions in later years. In the
terminal year, I dropped acquisitions down to $20 million to represent a rate of one acquisition every ten years.
Beta
I ran a three-year monthly regression against the S&P 500 and got a beta of 0.9129. I also ran a three-year weekly,
two-year monthly, and two-year weekly, which all resulted in very different betas. I ultimately decided to use the
beta from the three-year monthly because it took into account the entire period that DPS has been a publicly
traded company and because this beta is most in line with other estimates. I found a Hamada beta, but in
accordance with my lack of confidence in the comparability of DPS directly with other companies in the industry,
I decided that this beta did not accurately represent the risk of DPS going forward. Consequently, I decided that a
beta of 0.9129 best represented Dr Pepper Snapple’s risk and growth going forward.
11
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
Cost of Debt
Dr Pepper Snapple has six sets of unsecured notes with six different interest rates. Two of these sets of notes were
issued recently and come due soon with very low interest rates. As a result, the debt that is due farther in the
future is a better representation of Dr Pepper Snapple’s cost of debt. To calculate the cost of debt, I took a
weighted average of the three sets of unsecured notes that mature in 2016, 2018, and 2038. This gave me a cost of
debt of 5.59%.
RECOMMENDATION
Dr Pepper Snapple, Inc. is in a strong position to benefit from the recovering economy and improved consumer
sentiment. With a portfolio of powerful brand names, strong marketing, and focused management, DPS is going
to see revenue grow and operations become more efficient. However, their continued focus on carbonated soft
drinks could limit their growth as alternative and functional beverages gain popularity over unhealthy sodas.
Recently, Dr Pepper Snapple has been issuing larger dividends, repurchasing shares, and writing off debt. These
are all signs of a successful, stable firm with strong cash flows. For my quantitative valuation, I decided to weight
my comparables analysis at 0% and my discounted cash flow at 100%. For the reasons stated earlier in the report,
Dr Pepper Snapple’s comparable companies do not convey an accurate valuation of the firm. My discounted cash
flows resulted in a small undervaluation. Ultimately, Dr Pepper Snapple’s integrated business model and strong
brand portfolio, when coupled with the recovering economy, suggest that there is still value in this company. I
recommend a HOLD for both the Tall Firs and Svigals’ portfolios.
Method
Weighting Implied Price
DCF
100%
$43.57
Comparables
0%
$73.93
Target Price
Current Price
Undervalued
$43.57
$40.99
6.30%
12
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
APPENDIX 2 – DISCOUNTED CASH FLOWS ANALYSIS
!
14
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
APPENDIX 3 – REVENUE MODEL
!
APPENDIX 4 – NET WORKING CAPITAL
!
15
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
APPENDIX 5 – DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS
Assumptions for Discounted Free Cash Flows Model
Tax Rate
35.00% Terminal Growth Rate
Risk-Free Rate
3.06% Terminal Value
Beta
0.9129 PV of Terminal Value
Market Risk Premium
7.00% Sum of PV Free Cash Flows
% Equity
78.21% Firm Value
% Debt
21.79% LT Debt
Cost of Debt
5.59% Cash
CAPM
9.45% Equity Value
WACC
8.19% Diluted Share Count
Implied Price
Current Price
Undervalued
3%
16,392.15
7,611.57
4,430.93
12,042.50
2,182.00
657.00
9,860.50
226.30
43.57
40.99
6.30%
APPENDIX 6 – BETA SENSITIVITY ANALYSIS
Beta
1.4145
1.2891
1.1637
1.0383
0.9129
0.7875
0.6621
0.5367
0.4113
St. Deviation
2.00
1.50
1.00
0.50
0.00
-0.50
-1.00
-1.50
-2.00
Implied Price
24.96
28.28
32.30
37.28
43.57
51.81
63.02
79.18
104.47
Under (Over) Valued
-39.11%
-31.00%
-21.19%
-9.06%
6.30%
26.39%
53.75%
93.18%
154.87%
!
16
!
Dr
Pepper
Snapple
Group,
Inc.
University of Oregon Investment Group
http://uoig.uoregon.edu
APPENDIX 6 – SOURCES
•
•
•
•
•
•
•
•
•
SEC Filings
Dr Pepper Snapple Investor Relations
Yahoo! Finance
Google Finance
Reuters
Bloomberg
The Wall Street Journal
S&P NetAdvantage
IBISWorld
17
!