An Ominous Dr Pepper Ten
Herzog writes that she expects DPSG to achieve its productivity initiatives (while at a lower pace), control costs and preserve its shareholder-friendly style. Yet, these positives aren’t enough to alter the bank’s opinion of DPSG shares. The challenges of the CSD category, which has declined in volume nine consecutive years, remain prevalent.“We expect near-term pressure on the stock given our belief that the underlying valuation is not reflecting the near-term headwinds and longer-term structural challenges,” Herzog writes.
DPSG spokesman Chris Barnes told BevNET that the company will comment on April 23, when it announces earnings from the first quarter.In fitting fashion, considering DPSG’s struggling TEN platform, Herzog lists ten reasons why Wells Fargo has downgraded the company.
1) Recent Nielsen scanner data and Wells Fargo’s convenience store retailer survey indicate that DPSG sales declined in the first quarter of 2014. In the past four weeks ending on March 15, DPSG lost volume and value share and dollar sales declined 2 percent compared to the previous 12 weeks, according to Nielsen data of convenience stores and take-home channels.2) Given the company’s higher fixed-cost ratio and its limited opportunities to draw further savings from its Rapid Continuous Improvements program, Herzog expects margin erosion for the rest of 2014.
3) With the newly implemented soda tax in Mexico, DPSG expects a 7-8 percent decline in volume in that country, compared to the 5-7 percent decline projected by Coca-Cola FEMSA. This challenge has been exacerbated by the recent 6 percent devaluation of the Mexican peso compared to the U.S. dollar.4) Because the CSD category continues to decline and DPSG accumulates about 80 percent of its sales from the category, Herzog writes that DPSG is the most exposed of any CSD company to the ongoing negative trends.
5) Since Wells Fargo has begun tracking DPSG’s TEN platform in the first quarter of 2013, retailers have repeatedly stated that the line is struggling. The platform has generated weak repeat sales and many retailers have stopped carrying it.6) While the core strength of Coca-Cola and Pepsi will enable those companies to better stave off innovative up-and-comers, Herzog writes that brands such as Zevia (and other CSD innovators) will seize shelf space from DPSG’s “tier 2” products. As retailers show more interest in mixing up shelves, several DPSG products could prove highly susceptible to outright replacement.
7) Herzog writes that the company’s valuation multiple, which has increased from 8.2x in 2011 to 9.8x in 2014, has reached its peak level. Because of deteriorating macro-conditions, declining top-line growth and modest operating income growth, Wells Fargo believes that DPSG will likely trade closer to its 3-year average of 8.4x.8) Insiders sold 531,848 DPSG shares in the first quarter of 2014 — the most since DPSG began trading. Herzog writes that high insider sales figures often precede a sell-off in the stock in the following quarter.
9) Investors have long enjoyed DPSG’s strong dividend yield. In the past three years, DPSG’s yield has averaged 3.2 percent, compared to 2.7 percent from Coke and 2.9 percent from Pepsi. However, DPSG’s figure has declined to 3 percent, compared to Coke’s yield of 3.2 percent.
10) From 2010 to 2013, DPSG generated $3.8 billion in free cash flow, 92 percent of which was returned to shareholders via buybacks and dividends. However, because DPSG has decreased its capital spending every year since 2010, its assets have depreciated at a level greater than its expenditures, Herzog writes. This development is “an unsustainable trend in our opinion for any business expecting to grow.”
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