EUR 850.00 For Business Accounts Only

Morningstar | Keurig Dr Pepper Poised for Further Profitability Improvement Despite Tepid Sales Growth

Wide-moat Keurig Dr Pepper posted full-year results that largely aligned with our expectations, with revenue growth of 2.3%, adjusted operating margin around 23.8% (100 basis points of expansion), and adjusted EPS of $1.04 (all on pro forma basis) near our expectations of 2.1%, 23.0%, and $1.02, respectively. While management's guidance for 2% sales growth in 2019 falls below our 3% expectation, it reiterated its outlook for 15% to 17% adjusted EPS growth (our estimate falls at the high end of this range). We aren't anticipating a material change to our $22 fair value estimate or longer-term outlook, which calls for low-single-digit sales growth and above 26% average operating margin over our 10-year forecast, as we incorporate these results. Even with a mid-single-digit percentage decline in shares on the announcement, we'd suggest investors wait for a more favorable entry point.

Fourth-quarter pro forma sales growth was relatively lackluster, up just 0.5% as a 2.7% improvement in volume/mix was partly offset by a 1.8% headwind from changes in the firm's Allied Brand portfolio and a negative 0.4% impact from currency. However, we remain constructive on the firm's potential for bottom-line expansion. Adjusted pro forma operating margin expanded 280 basis points to 25.6%, thanks to cost savings and better leveraged general and administrative expenses, as well as lower marketing spending. While we expect substantial improvements in profitability over the next several years (with $200 million of annual cost savings from 2019 to 2021 supporting high-single-digit average operating income growth over this time frame), we contend the firm will have to maintain substantial investments behind its brands to defend its competitive stance. In this context, we maintain the firm will reinvest 40% of these cost savings in marketing and research and development to bolster product innovation and support momentum in its core brand portfolio.

From a segment perspective, beverage concentrates (12% of sales) was the key driver of top-line growth, with fourth-quarter net sales up 4.8% (with balanced contributions from price and volume/mix) due to strength in the firm's core carbonated soft drink brands, such as Dr Pepper, 7UP, Schweppes, and Sunkist. In contrast, revenue in the coffee systems segment (37% of sales) fell 0.5%, primarily due to a 3% decrease in pricing from the firm's ongoing efforts to increase the affordability of its coffee pods; we expect pod pricing to stabilize over the next few years. However, we think greater affordability will enhance consumer penetration (management estimates household penetration of the Keurig brewing system has expanded 7% over the last year to roughly 22%), and our confidence is buoyed by an 8.6% increase in K-Cup pod volume during the quarter.