Tuesday, January 13, 2009

Soda Stocks: Falling Flat or Plenty of Fizz?

As economic and stock market conditions continue to show little improvement, investors naturally look for safe havens to make investments. The good-times goal of appreciation of almost seems like wishful thinking; preservation of capital is the more important goal for many investors.

One usual area of perceived relative safety are consumer necessities. Companies like J&J, McDonalds, and Wal-Mart have attracted investors as stocks of more discretionary purchases (premium clothing, travel, premium restaurants) have tanked.

As an appreciator of many things fizzy, I decided to take a look at various beverage companies who may enjoy some benefits in a rough market as an area of perceived safety.

First is Coca-Cola (KO), a company that has been a longtime favorite of Warren Buffet. KO has actually fallen by an amount similar to the general market - shares are now down about 30% off of their 52-week high. Coke is one of the most recognizable brands worldwide, and shares have historically enjoyed generous valuations because of that valuable brand power. Though the stock's current PE of 17 doesn't seem cheap, it is compared to KO's 5-year average of 20. KO's PE is even higher if the time frame is expanded beyond five years; during the rougher few prior years, KO's PE was close to 30 for much of the time. (Full table here from Morningstar.com) Price-to-sales and Price-to-CF ratios are trading at similar discounts to historical levels, implying that KO could realize 30+% of upside if it were to trade back at historical valuations. In the mean time, the stock is currently yielding roughtly 4%, which isn't bad considering the pathetic yield in Treasuries at the moment.

Many parallels can be drawn between KO and Pepsico (PEP). KO's beverages do outsell Pepsi's worldwide, but Pepsico owns the valuable Lay's snackfood brands and has done well increasing sales of non-soda beverages. (Pepsi's purchase of Quaker Oats years ago brought the Gatorade brand under the Pepsi umbrella, and other drinks such as Tropicana juices are also great sellers). Pepsi is trading at cheaper valuations relative to KO and to its historical averages: PEP's PE is now 14.7, compared to a 5-year average of 20.6. PEP's P-to-S ratio is 2, compared to a historical average of 3. With strong brands providing stable sales, an investor should be able to park money in either Pepsi or Coke, enjoy respectable yields (Pepsi's is about 3%), and eventually sell the shares for a nice capital appreciation.

Looking beyond the two biggest players, there are some other noteworthy opportunities.

Cadburry spun off Dr. Pepper Snapple Group (DPS) about a year ago as capital markets were freezing and a highly-leveraged private equity buyout was no longer an option. DPS was initially sold around $25/share; after touching $27 soon after the spin off, shares sunk during general market weakness and now trade for around $16. DPS has a narrower focus than KO and PEP, with a much more limited brand spectrum and operations in only North America, Latin America, and the Caribbean. (DPS also engages in some bottling and distribution activities, while KO and PEP sell primarily syrups and let bottlers do the less profitable work). However, DPS looks very cheap compared to its two bigger peers, which may even make it a takeover target. DPS is expected to earn about $1.75/share this year, giving shares a very attractive 9 P/E. Price to sales are just 0.7, compared to PEP's 2 and KO's 3.2. Price-to-Cash Flow for DPS is just ten, providing a buyer with a steady stream of cash from its investment. With a market cap of just $4 billion, compared to KO's $100b and PEP's $80b, DPS may seem too attractive to pass up soon. (KO actually currently has $8b of cash sitting on its balance sheet, so a buyout wouldn't need any additional financing). Investing solely on the basis of expecting a buyout is risky, but DPS's fundamentals justify buy shares nonetheless.

Hansen Natural (HANS) is a maker of energy drinks, notably the Monster brand. HANS is a faster growing company than the soda makers, but skeptics often worry that energy drinks may be a fad. As a consumer, I can understand both bullish and bearish arguments about the business model - I do buy and love energy drinks, but I have cut back consumption as cheaper alternatives (coffee) exist. Also, energy drinks are becoming commoditized; I saw 99 cent energy drinks popping up in convenience stores in Pittsburgh, which should erode market share from the $2.29 Monster. HANS has done a good job of widening distribution and introducing new beverages (coffee-like drinks, etc.), but I have to believe that the growth will fizzle out eventually. Since the topic of this post is safety stocks, I'll exclude HANS - but there is a good chance that it may outperform KO, PEP, and DPS if management continues to execute well.

Lastly, I'll throw Jones Soda's name into the blogosphere. JSDA is a maker of relatively expensive, high-quality sodas. JSDA has had some successes getting their sodas into more stores, but the company isn't profitable and trades at $.38 for a reason. However, JSDA might work out as a very speculative bet. Jones Soda drinkers are often very fond of the brand, and thanks to wide distribution in Starbucks in the past, it has become somewhat of a household name. A recovery is clearly priced in as being unlikely, but if management can turn the company around, take it private, or sell out, there could be huge upside.

In conclusion, KO and PEP provide great places to park money in a wild market. DPS trades at a cheaper valuation than KO and PEP, and should recover strongly or be bought out. HANS has been one of the hottest stocks of the past half-decade, but such companies often fizzle out. And, if you're too cheap to fly to Vegas, buying JSDA might mirror betting on a single number in roulette; you'll likely lose, but any winnings should be big.

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