Dr Pepper Posts Higher Profit

Zacks

Dr Pepper Snapple Group Inc. (DPS) reported second quarter 2012 adjusted earnings (excluding mark to market losses) of 85 cents per share, up 8.9% from the year-ago earnings of 78 cents per share. Earnings increased on the back of revenue growth and increase in margins. The company’s quarterly earnings also surpassed the Zacks Consensus Estimate of 82 cents per share.

During the quarter, Dr Pepper's net sales grew 2% (3% excluding the effect of foreign exchange) year over year to $1.6 billion. A benefit of 4% from price/mix was offset by a decline in volume and unfavorable currency impact of 2% in the quarter. Net sales were in line with the Zacks Consensus Estimate.

Quarter in Detail

Dr Pepper Snapple Group Inc. manufactures and distributes a varied product range of flavored carbonated soft drinks (CSDs) and non-carbonated beverages (NCBs). Dr Pepper owns some well-established CSD brands such as Dr Pepper soft drink, 7UP, Canada Dry, Schweppes ginger ale, Peñafiel mineral water, Royal Crown Cola and many more. Popular NCB brands include Snapple tea, Hawaiian Punch, Mott’s apple juice and sauce, Aquafiel mineral water, Clamato tomato juice and others.

Dr Pepper’s sales volume is measured in two ways: 1) sales volume and 2) bottler case sales (BCS) volume. Sales volume represents sales of concentrates and finished beverages sold to bottlers, retailers and distributors. Bottler case sales includes sales of packaged beverages by the company and its bottlers to retailers and independent distributors.

In the quarter, BCS volume slipped 1%, which included a flat volume in CSD’s and a 6% decline in NCBs. In CSD, Dr Pepper soft drink sales were up 1% driven by the low calorie drink Dr Pepper Ten (launched in the fourth quarter of 2011) and volume growth in the fountain food service business.

Mid single-digit volume growth in Canada Dry, A&W was offset by double-digit decline in Sun Drop and a low-single digit decline in 7UP. The core 5 brands (Canada Dry, A&W and Sunkist soda, 7up and Sun Drop) together delivered a volume growth of 1%. All other CSD brands went down by 2% due to a decline in Crush. Fountain food service volume went up by 3% year over year.

Among the NCBs, growth in Snapple and Clamato was offset by double-digit volume declines in Hawaiian Punch and Mott’s due to price increases implemented in 2011.

Sales volume, as discussed before, was down 1% in the quarter as branded volumes were down by 2% and contract manufacturing volumes went up.

The company reported consolidated adjusted operating income of $293 million in the second quarter, up 3.5% from the prior-year period on the back of revenue growth and benefits from productivity improvement. Reported operating income (including mark to market gains) was down 2% from the prior-year quarter. In the quarter, marketing spend was up $9 million and the company also incurred an $8 million pre-separation-related non-cash charge during the quarter.

Segment Details

Beverage Concentrates: The division manufactures and sells beverage concentrates in the US and Canada, which is used primarily to produce CSDs. Dr Pepper's net sales from Beverage Concentrates went up 3% year over year to $331 million in the second quarter, as lower discounts and favorable mix were partially offset by a 2% volume decline. Segment operating profit was down 1% to $214 million due to increased marketing and ingredient costs.

Packaged Beverages: The division manufactures and distributes finished packaged beverages (both CSDs and NCBs) and other products, including its own brands, third party brands and private label beverages in the US and Canada. In the Packaged Beverages segment, net sales increased by 4% to $1.2 billion, boosted by favorable mix and higher pricing including lower discounts. Segment operating profit increased 9% to $150 million as revenue growth was offset by commodity and packaging cost headwinds.

Latin America Beverages: The division manufactures and distributes carbonated mineral water, flavored CSD, bottled water and vegetable juice in Mexico and the Caribbean. Dr Pepper's net sales from Latin America Beverages increased 1% to $113 million, mainly helped by favorable product mix and higher pricing. Segment operating profit was flat at $15 million, primarily benefiting from sales growth, better operating leverage and foreign exchange tailwinds, which mitigated the higher packaging and ingredient costs.

Balance Sheet and Cash Flow

Dr Pepper ended the second quarter with cash and cash equivalents of $303 million and long-term debt of $2.02 billion compared with a cash balance of $192 million and long-term debt of $2.25 billion at the end of the first quarter of 2012.

In the quarter, the company bought back shares worth $152 million, paid $141 million in the form of dividends and incurred capital expenditure of $89 million.

Outlook

Dr Pepper maintained its full year 2012 earnings and sales guidance. Full-year 2012 adjusted earnings are expected to be in the range of $2.90 to $2.98 per share, benefiting from share repurchases. The company expects full-year sales growth rate to come at the lower end of its long-term forecast of 3% to 5%.

The company projects cost of goods sold to increase by 2% due to higher packaging and ingredient costs. Full-year tax rate is expected to be about 37%.

Our Recommendation

We currently have a Neutral recommendation on Dr Pepper Snapple. The stock carries a Zacks #3 Rank, which translates into a short-term Hold rating.

Overall, we are encouraged by Dr Pepper’s strong position in the flavored CSD market. Moreover, the company’s Rapid Continuous Improvement (RCI) program is also resulting in cost savings and improved cash flows. The company’s priority brand licensing agreements with PepsiCo, Inc. (PEP) and The Coca Cola Company (KO) boost sales of the branded products that are a part of the agreement.

However, the weak volumes, lack of exposure outside the US, a difficult macro-economic environment and rising input costs keep us on the sidelines.

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