The Dr is in good health, say analysts

The Dr is in good health, say analysts

Shares of Dr Pepper Snapple Group have been under pressure following its long-awaited licensing deal with The Coca-Cola Co, but many analysts think the group has reason to be cheerful. Michelle Russell examines market reaction to this week's agreement.

Coca-Cola will pay it US$715m to gain the distribution and bottling rights to key Dr Pepper Snapple (DPS) drinks brands in several US states. Coca-Cola must buy the rights from Coca-Cola Enterprises (CCE) as part of its takeover of the bottler’s North American business.

Coca-Cola CFO Gary Fayard told reporters on Monday (7 June) that the deal was fair to both companies, and that the Pepsi and Coke deals differed in some important respects, such as Dr Pepper's gamble on Coke's new fountain machines.

Fayard added: "I'm most excited ... that [Dr Pepper Snapple] would view our new Freestyle technology as disruptive enough to the industry that they were willing to put $125m against it just to have access to it."

DPS shares slipped 1% on news of the windfall, which was slightly less than the $800m most analysts had expected. DPS gained $900m earlier this year for a similar deal with PepsiCo after it, too, acquired its major bottlers.

Deutsche Bank analyst Marc Greenberg told Reuters that he had expected Coca-Cola’s payment to range from $900m to $1bn, but that the deal ultimately reached offered DPS more long term growth.

"DPS has traded some cash up front for long-term opportunity to expand its flagship brand nationally," Greenberg said. Yet, he added that it was hard to put a dollar estimate on the ultimate profit opportunity.

Credit Suisse analyst Carlos Laboy agreed: "We believe some investors expected a higher payment to come from Coke. We have heard from investors who were expecting the number to be north of what PepsiCo paid."

Meanwhile, Morningstar analyst Philip Gorham said that PepsiCo was getting a better deal than Coca-Cola, even though Coca-Cola will pay less than PepsiCo.

"CCE does not distribute Dr Pepper products in Mexico, as Pepsi Bottling Group did, and we expect volume to continue to increase in the medium term in this important growth market, giving Pepsi's deal the edge, in our opinion," Gorham said.

DPS CEO Larry Young said he was confident the company will reap benefits from the licensing deals.

“These agreements build a strong foundation for the continued growth of Dr Pepper and our leading flavour brands," he said. "It solidifies Coke’s support of the Dr Pepper trademark while enabling us to optimize our route-to-market by assuming distribution of several key brands. Additionally, we’re increasing our fountain presence…a great win for Dr Pepper.”

He said that DPS can do better than the official company projection of 3% to 5% annual sales growth over the next several years.

CLSA analyst Caroline Levy has “higher conviction” in her “buy” rating on Dr Pepper.

She likes the company’s efforts to expand into healthier drinks, such as Vita Coco coconut water, which it will begin redistributing in Florida and Georgia.

The Coca-Cola deal also helps DPS “regain control of smaller brands that would likely never merit much attention from a third-party distributor,” said Levy. She added that this will “help give critical mass in markets like Southern California”.

It is unknown whether the Coke-DPS agreement includes a charge-in-control clause that would trigger a renegotiation should Coca-Cola spin off the bottling company, as has been speculated.

With the initial terms of the DPS-Coke deal set at 20 years, with 20-year renewal periods, it is possible that ownership of the bottler could change before the deal expires.

"We were all very aware of what the potential US bottling system could evolve into," Coca-Cola's Fayard told Bloomberg News. "We anticipated all of that as we negotiated the transaction."

Yet, while some analysts have questioned the strategy, DPS' practice of splitting its allegiance between Coca-Cola and PepsiCo for distribution gives the company leverage, industry insiders have said.

Indeed, the company’s stock is up 64% over the past 12 months.

"You’ve got a management team that’s very focused," said Stifel Nicolaus analyst Mark Swartzberg. "There’s real money behind that focus."

John Sicher, editor of Beverage Digest, called Dr Pepper “a very important brand”.

"Years ago, Dr Pepper's franchise model was to pick the best bottler in a given territory. That has worked well for decades and has been partly responsible for the brand's growth from a regional soft drink to a major national brand,” he said.

The Dr Pepper brand, one of the strongest performers in the soft drink market last year, accounts for about one-third of the company's volume.

It is only a few years since Texas-based DPSG emerged from its position as the unwanted stepchild of Cadbury Schweppes, but the group's future looks promising.