Keurig Dr Pepper: A defensive stock in an uncertain market.
Opdateret: 27. okt. 2022
Keurig Dr Pepper has performed well so far in 2022 and is up nearly 9 % at the time of writing, while the S&P 500 index is down nearly 12 %. Keurig Dr Pepper could potentially continue to outperform the market if we are headed into a recession. In this analysis, I will investigate if Keurig Dr Pepper is a stock that you should add to your portfolio and at what price.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that the time of writing this analysis, I do not own shares in Keurig Dr Pepper or in any of their direct competitors. If you want to copy the portfolio or want to see which stocks I hold, you can read how to do so here. As I have no skin in the game or any prior opinion when it comes to Keurig Dr Pepper, I believe it is relatively easy to keep the analysis unbiased.
Keurig Dr Pepper was formed in 2018 when Keurig acquired Dr Pepper Snapple group. Hence, Keurig Dr Pepper is now known as a beverage company that has a portfolio of carbonated and non-carbonated soft drinks and single serve coffee. Most Europeans probably know Keurig Dr Pepper for their soft drinks such as Dr Pepper, 7 up, Snapple, and A&W root beer and cream soda. However, their single service brewing system Keurig is very popular in North America, as 36 million households owns a Keurig brewing system. While Keurig Dr Pepper isn't making profit on the brewing systems, they are making profit on their K-Cup pods that are used for their brewing systems. They K-Cup pods can be their own labels such as Green Mountain but also brands through partnerships as they have with McCafé. In their annual report Keurig Dr Pepper mentions that many of their brands enjoy high levels of consumer awareness, preference and loyalty rooted in their rich heritage. I agree with the statement, which is why I believe that Keurig Dr Pepper has a brand moat.
Their CEO is Ozan Dokmecioglu. He is completely new in this role, as he became CEO in July 2022. He served as the CFO prior to becoming CEO and has been acknowledged as a key architect of the merger strategy between the two companies that created Keurig Dr Pepper. He has vast experience in the beverage industry in which he has been a part of for more than 25 years. Prior to joining Keurig Dr Pepper, he held various positions in companies such as Kellogg's and Kraft Foods. He also serves at the Board of Directors at Krispy Kreme. He holds a bachelor's degree in Business Administration from the Middle East Technical University in Ankara, Turkey. He also has a certificate in Project Investment and Appraisal Management from Harvard University. It isn't possible to judge if Ozan Dokmecioglu is a good CEO yet and we don't have any employee scores on him as a CEO after so little time in the job. However, Ozan Dokmecioglu has been part of a management that has delivered a a CAGR on EPS of 15,4 % since the merger, while staying prudent on other acquisitions. Former CEO Bon Gamgort commented on acquisitions in the latest earnings call: "We are up for acquisitions and we have done some of those which has performed well in our business, but we are not going to overpay and we have never been caught up in valuing anything on a multiple sales." I believe that Ozan Dokmecioglu will continue the prudent stance on acquisitions and I'm willing to give him the benefit of the doubt moving forward.
I believe that Keurig Dr Pepper has a brand moat. There are some uncertainties regarding management but I'm willing to give them the benefit of the doubt. Now let us investigate the numbers to see, if Keurig Dr Pepper lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all years. It is curious to see that the prior to the merger Keurig had better numbers than after the merger. I'm far from impressed with the numbers since the merger but it is positive to see that the numbers are trending upwards. Since the merger is still relatively new, I will not completely discard Keurig Dr Pepper on these numbers, but I would like to see them continue to increase as we are moving forward.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Not surprisingly, we see a huge increase in 2018 due to the merger. It is positive to see that their equity has grown each year since the merger, even during the pandemic year of 2020. These numbers are encouraging, while they don't completely offset the disappointing ROIC.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditure. As with the other numbers, it is most important to look at the numbers from 2018 moving forward. Free cash flow decreased a bit during the pandemic, but it isn't something that I will give too much importance. It is nice to see that free cash flow reached a record high in 2021, which is the last number we have. While you cannot see it in this table, management mentioned another encouraging thing regarding free cash flow in their latest investor day, and that is that Keurig Dr Pepper has delivered a free cash flow yield of 3,2 % in the last 12 months compared to 2,1 % average of their beverage peers (peers are these tickers: BUD, SAM, KO, STZ, TAP, MNST, FIZZ, PEP and SBUX). It is of course very encouraging that Keurig Dr Pepper has outperformed their peers.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. Doing the calculation on Keurig Dr Pepper, I can see that Keurig Dr Pepper has 5,4 years earnings in debt. It is higher than what I would like. However, management has prioritized to pay down debt from the acquisitions and if they continue to do so, I don't find it too alarming.
Based on my findings so far, I believe that Keurig Dr Pepper is a good company. However, no investments are without risk and Keurig Dr Pepper has some risks as well. One risk that management mentioned in both their annual report and in their latest earnings call is macroeconomics. In their latest earnings call management mentioned that they experienced cost of goods sold inflation across all inputs like ingredient, packaging, manufacturing labor, transportation, and warehousing. While they may be able to transfer some of these costs to consumers, it will hurt profits as rising prices will come at a delay compared to rising consumer prices. It is impossible to predict how long these factors will hurt Keurig Dr Pepper, but it will hurt profitability short-term. Competition. In their annual report Keurig Dr Pepper mentions that they are operating in intensely competitive categories. They mentioned they compete with large multinational corporations like Coca-Cola, Pepsi, and Nestlé that have financial resources, which can be used to rapidly respond to changes in consumer preferences by introducing new new products, while their financial resources also make it possible to reduce prices. Keurig Dr Pepper also compete with smaller competitors that may be more innovative and are better able to quickly exploit and serve niche markets. High debt and low ROIC. Finally, I believe that high debt and low ROIC is a risk. Keurig Dr Pepper is still a new company, but they will absolutely need to continue to pay off their debt as they have done in the last couple of years. Hence, it is something that needs to be monitored if you are invested in Keurig Dr Pepper. Furthermore, I would need to see ROIC continue to increase year over year, as they have delivered a very disappointing ROIC since the merger in 2018.
It isn't all doom and gloom. There are also reasons to invest in Keurig Dr Pepper. Should perform well during a recession. We are technically in a recession in the United States. Hence, it is worth looking at companies that should perform well during recessionary periods. During the recessionary periods in 2008 and 2009, carbonated soft drinks and coffee were among the best performing consumer packaged goods categories. Management elaborated about it in their latest earnings call and mentioned that these categories have regular consumption behaviors and few direct substitutes, while they also benefit from the trade down effect from out of home consumption to in home consumptions that frequently occurs during recession. Growth in coffee systems. Keurig Dr Pepper has a strategy that is focused on attracting 2 million new households every year into the Keurig system. Management believes that the total addressable market is more than 50 million, and as they have 36 million existing costumers, it means that management predicts household growth for the next 10 years. Furthermore, the strategy also focuses on driving revenue and profit growth among their existing customers through new platforms through new beverage formats and occasions. Growth in cold beverages. Keurig Dr Pepper has a strategy that focus on driving growth through their core brands through marketing and renovation to fill white space in their portfolio. Management believes that internal innovation, external partnerships, more effective omni-channel, and their distribution system will lead to continued share growth. According to Grand View Research, the carbonated soft drink market is expected to grow by a CAGR of 4,7 % until 2028, while the non-carbonated soft drink market is expected to grow by a CAGR of 6,9 % until 2028. If Keurig Dr Pepper can gain market shares over the time frame, their cold beverages segment will grow at a larger pace.
All right, we have gone through the numbers, potential and risk regarding Keurig Dr Pepper, and now it is time for us to calculate a price for Keurig Dr Pepper. To calculate price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website, as I do not want to go through the whole calculation here. I chose to use an EPS of 1,5 which is the one from 2021. I chose an Estimated future EPS growth rate of 9 (management expects EPS to grow at a high single digit), Estimated future PE 18 (which the double of the growth rate, as the historically PE for Keurig Dr Pepper has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $15,8, and we want to have a margin of safety on 50 % so we will divide it by 2, meaning that we want to buy Keurig Dr Pepper at price of $7,9 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 2.870 The Capital Expenditures was 455. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 318,5 in our further calculations. The Tax Provision was 653. We have 1.415,7 outstanding shares. Hence, the calculation will be like this: (2.870 - 318,5 + 653) / 1.415,7 x 10 = $22,64 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 1,95 and a growth rate of 9 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $23,44.
I believe that Keurig Dr Pepper is an interesting company. They have a strong brand moat and will probably perform well during recessionary times as explained previously in the analysis. The CEO is still unknown for now but has vast experience in the industry and has been part of the management group prior to becoming CEO. Hence, I'm willing to give management the benefit of the doubt. The historic ROIC since the merger is concerning for me and I would like to see management delivering better numbers moving forward, which I believe they will, as they pay down debt. Macroeconomics will affect profits in the short-term, but it isn't overly concerning to me. And while Keurig Dr Pepper is facing tough competition, they do have a moat that should give them protection. I especially see their coffee segment to be a growth catalyst moving forward. Once consumers buy the machines, they will also buy the K-Cup pods, which leads to recurrent income. It seems like consumers are happy with the product, as management sold 11 million machines in 2021, and while 3 million were new customers, the last 8 million upgraded their machine. I may add Keurig Dr Pepper to the portfolio, if I can buy at the PAYBACK TIME price at $23,44.
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