Dr. Pepper: Good Buy or Guaranteed Loss?

By Joshua Robbins


The old saying, “you can’t always get what you want” comes from the time when Dr. Pepper, which is one of the oldest brand names in Soda history, was invented. The 23 secret flavors that create this Soda are what keep this Soda selling. Yet, the debt that this company holds on its books might eventually close the doors and cause it to be sold off, yet again.

Dr. Pepper and Snapple is what many could call the hot potato of the industry. Given the fact that it can never really compete with major brands such as Pepsi and Coca-Cola, there is good reason not to invest in this stock and that would be international recognition. This soda has no place in the European Market. The second case I could make against Dr. Pepper would be that there is not market for an older generation soft drink. Teens are obsessed with energy drinks and rightfully so as these types of pushed down the throat of popular culture. Thus, the changes of tastes are taking place, yet no change of DP’s part. More importantly, what will eliminate any hope for a solid investment are the books of this company. Yes, DP has a strong name and the parent company Cadbury brings a lot to the table as well such as other names as Snapple and 7-UP. But the debt created in the past from marketing and bottling has tied up any future development of any new products. And what they have recently tried, chocolate flavored soda, well the name states it for it’s self. Never the less, we will pass on the psychological fundamentals of business and look at the hard facts; that being the books.


Quick Facts:

Originally Dr. Pepper was valued at 16 billion dollars, now it is valued at 6 billion dollars.
Its major competitors are Coke, Pepsi, and Kraft Foods.
The sector in which DP trades is Consumer Goods.
The Industry is Beverages and Soft Drinks.
Just recently spun off of Cadbury in early May.

Key Statistics

I think it is important to the look at the amount of employees that DP currently has. To me, this tells me what the business is like and where it is going. Currently, DP has only 20,000 employees. This is relatively small compared the mega brands of Coke with 90,000 employees and Pepsi’s 185,000 employees. The quarterly revenue growth for DP is only 3.40 %. This is small compared to Coke 20.90 % and Pepsi’s 13.40 %. Considering the industries average of 1.44 billion in revenues, DP does in fact make almost five times that amount at 5.75 Billion. Again, this number is blown out of the water by Cokes 30 billion and Pepsi’s 40 billion.

DP’s gross margin is right on par with the numbers of the other competitors. Yet, there is a tricky way of looking at gross margin that shows that this is not a good think as 50% of the profits are being eaten up by debt. Gross margin can be defined as the amount of contribution to the business enterprise, after paying for direct-fixed and direct-variable unit costs, required to cover overheads (fixed commitments) and provide a buffer for unknown items. It expresses the relationship between gross profit and sales revenue.
It can be expressed in absolute terms:

Gross Profit = Revenue − Cost of Goods Sold

or as the ratio of gross profit to sales revenue, usually in the form of a percentage:
Cost of goods sold includes variable and fixed costs directly linked to the product, such as material and labor. It does not include indirect fixed costs like office expenses, rent, administrative costs, etc.

Higher gross margins for a manufacturer reflect greater efficiency in turning raw materials into income. For a retailer it will be their markup over wholesale.
Larger gross margins are generally good for companies, with the exception of discount retailers. They need to show that operations efficiency and financing allows them to operate with tiny margins (wiki). In the terms of Coke and Pepsi, this really doesn’t matter when you are pulling down 30 to 40 billion a year in revenues. When you are only bringing almost 6 billion to the table, which begins to tax the investor’s pocket and this dilutes the share price.
Another area of concern for DP is the operating margin. This again is on par with Pepsi and Coke at almost 18%. Operating margin is the ratio of operating income (operating profit in the UK) divided by net sales, usually presented in percent. It is a measurement of what proportion of a company's revenue is left over, before taxes, after paying for variable costs of production as wages, raw materials, etc. A good operating margin is needed for a company to be able to pay for its fixed costs, as interest on debt (wiki).

Ratios:

The current P/E for DP is zero. Which means this is a buy waiting to explode or investors have absolutely no confidence in this stock, you will have to decide which way you swing. The average industry P/E is 16.38. So multiply 1.8 (which is DP’s EPS) times 16.38 and that should give you its fair market value which is $ 29.84. Given that the current share price is around 25.50, then there is little to gain and a lot to lose. The PEG Ratio 1.6 which is a bit frightening. The PEG Ratio, Price/Earnings To Growth, is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share (EPS), and the company's expected growth.A lower ratio is "better" (cheaper) and a higher ratio is "worse" (expensive). A PEG ratio that approaches two or goes higher than 2 is believed to be too high. This means that the price paid appears to be much too high relative to the projected earnings growth.
PEG is a widely employed indicator of a stock's possible true value. The PEG ratio of 1 represents a fair trade-off between the values of cost and the values of growth, indicating that a stock is reasonably valued given the expected growth. Similar to PE ratios, a lower PEG means that the stock is undervalued more. It is favored by many over the price/earnings ratio because it also accounts for growth. If a company is growing at 30% a year, then the stock's P/E could be 30 to have a PEG of 1. PEG ratios between 1 and 2 are therefore considered to be in the range of normal values. A crude analysis suggests that companies with PEG values between 0 to 1 may provide higher returns.

The PEG ratio is commonly used and provided by various sources of financial and stock information. The PEG ratio, despite its wide use, is only a rule of thumb and has no accepted underlying mathematical basis; the PEG ratio's validity at extremes in particular (when used, for example, with low-growth companies) is highly questionable. It is generally only applied to so-called growth companies (those growing earnings significantly faster than the market).
When the PEG is quoted in public sources it may not be clear whether the earnings used in calculating the PEG is the past year's EPS or the expected future year's EPS; it is considered preferable to use the expected future growth rate.

It also appears that unrealistically high future growth rates (often as much as 5 years out, reduced to an annual rate) are sometimes used. The key is that management's expectations of future growth rates can be set arbitrarily high; this is a self-serving ploy where the objectives are to keep themselves in office and to make the stock artificially attractive to investors. A prospective investor would probably be wise to check out the reasonableness of the future growth rate by checking to see exactly how much the most recent quarter's earnings have grown, as a percentage, over the same quarter one year ago. Dividing this number into the future P/E ratio can give a decidedly different and perhaps a more realistic PEG ratio (wiki).

Trends
As for any trends, it is rather difficult to isolate this so early in the game. I need a solid year of earnings, and then I will be able to decipher the information.

My Investor Hat:
I think the Dr. Pepper has a way to go before it becomes a powerhouse such as Coke and Pepsi. I also feel that they need to find a cheaper more efficient way of doing business. Until this happens, I feel this stock is at its current value and it is to much of a risk to grab 9-10 % especially in the current marketplace. I believe that this stock is a hold till 30 then sell if you already own it and if you don’t, don’t buy.