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Neutral on Dr Pepper Snapple

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We have maintained a Neutral rating on Dr Pepper Snapple Group Inc. (DPS) following appraisal of fourth quarter and fiscal year 2011 results.

Dr Pepper reported fourth-quarter 2011 earnings of 82 cents per share, up 22.4% from the year-ago earnings of 67 cents per share. The company’s quarterly earnings also surpassed the Zacks Consensus Estimate of 74 cents per share.

During the quarter, Dr Pepper's net sales grew 3% year over year (4% excluding the impact of foreign exchange) to $1.46 billion and also swept past the Zacks Consensus Estimate of $1.45 billion. The year-on-year growth was mainly attributable to price increases and a favorable mix.

The company entered into priority brand agreements with cola giants PepsiCo, Inc. (PEP) and The Coca Cola Company (KO) in 2010. These initiatives also helped boost the top line. The priority brand agreements ensure that the popular brands of Dr Pepper are included in all core packages, major merchandising events and display activities that Coca Cola and PepsiCo participate in, thus boosting sales of these brands. Sales volumes however declined in the quarter.

Overall, we are encouraged by Dr Pepper’s strong position in the flavored carbonated soft drinks (CSD) market. Dr Pepper owns some of the most popular CSD and non carbonated beverages (NCB) brands. It holds the #1 position in the flavored CSD market in the US with a market share of 40% in the US in 2011.

Dr Pepper soft drink, the most popular CSD brand, holds the #2 position in the flavored CSD market in the US. The company’s portfolio of well-established flagship brands offers a strong competitive advantage and strengthens its well-established position in the market. The well-liked brand portfolio also leads to impressive margins and cash flows.

In 2010, Dr Pepper launched its Rapid Continuous Improvement (RCI) program under which the company is working to free up critical resources, people, time and money so that these can be used to build brand value. Therefore, the company has been able to reduce inventory and storage costs and improve cash flows which can in turn be returned to shareholders via dividends and share repurchases. Dr Pepper anticipates that the program will lead to a cash productivity of at least $150 million through 2013 with $57 million already achieved in 2011.

However, weak volumes, lack of exposure outside US, a difficult macroeconomic environment and rising input costs keep us on the sidelines. The macroeconomic environment was weak in 2011 as rising costs of raw materials resulted in price increase for the finished products. Price hikes discouraged consumers from indulging in discretionary spending.

The company’s customers also remain sensitive to other macroeconomic factors including interest rate hikes, credit availability, unemployment levels, and high household debt levels, which may further dissuade them from unnecessary spending. At the end, these may affect the company’s growth and profitability. Changing consumer preferences and increasing health consciousness also limit the company’s CSD sales.

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