Thursday, May 9, 2013

Be A Pepper

One of my favorite stocks in the consumer staples space is Dr. Pepper Snapple (DPS).

It's not that I am a big fan of carbonated soft drinks - I find they usually make more thirsty after I drink one than before - but this is a very straightforward, understandable story.

The company sells its well-known products almost entirely in North America. It signed 20-year agreements in 2010 with Coke and Pepsi to distribute Dr. Pepper and Snapple to stores and restaurants. I have seen management in person a couple of times, and have been impressed with their candor and honesty.

Because of its simplicity, and because it is not an "emerging markets story", many analysts are less enthusiastic about the company.  Growth in carbonated beverages in the U.S. and Canada has been non-existent for the last few years, and they believe that the stock does not fully reflect the risks to future growth that the company faces.

The May 8, 2013, issue of Fortune magazine carried an article about Dr. Pepper, and how management plans to respond to its challenges.  Here is an excerpt:

So how do you fight the soda wars on the home front? There are several ways, one of which is to get away from "cola." Most of the soft-drink fatigue you hear about, Young insists, is actually "cola fatigue." He says Dr Pepper differs from Coke and Pepsi because it emphasizes flavored soft drinks. According to the company, many of its brands lead their flavor category. The company's brand A&W is the top-selling root beer, for example, and Squirt is the top-selling grapefruit soda...

Another tactic is to squeeze as much profit as possible by making sure operations are efficient. At Dr Pepper, Young has built a "hub and spoke" distribution model. Cadbury used to distribute exclusively from plants in the Northeast U.S. But after the spinoff, Young identified five places around the U.S. to build centers and distribute from there. That saves on fuel costs, he says, and has the added benefit of getting the product into customers' hands more quickly.

My one concern about DPS is valuation.  Even though it sports a 3.1% dividend yield, the stock is trading at a P/E of 16x, which is at the upper end of its historic range.

Still, with investors thirsty (pardon the pun) for dividend-paying stocks from good companies, DPS should continue to do well in the months ahead.