EUR 850.00 For Business Accounts Only

Morningstar | Monster Gross Margin Continues to Falter Amid Substantial Top-Line Growth; Shares Still Aren’t Cheap

Monster reported solid third-quarter results, with net sales growing 12%, driven by low-teens growth in the Monster Energy segment (which includes its namesake offering and contributes 92% of sales) and only minimally impacted by a low-single-digit decline in its Strategic Brands (brands acquired from wide-moat Coca-Cola like Full Throttle and NOS). However, a mix shift from both a product (Strategic Brands use a higher-margin concentrate model) and geographic perspective (as international markets continue to fuel sales) continued to weigh on profitability, with gross margin contracting 280 basis points to below 60% (including a 50-basis point headwind from the adoption of a new accounting standard). Further, input cost inflation (primarily for aluminum and freight), which has plagued firms across the industry, also dented gross margin. Longer-term, we think Monster's growing scale in international markets and better leveraged operating costs will help counter this mix effect and drive further margin expansion. In this context, selling expenses leveraged 150 basis points during the quarter to 11% and general and administrative expenses leveraged 70 basis points to 11%.

Year to date, net sales growth is tracking slightly ahead of our outlook at nearly 13% (versus our 10% to 11% full-year estimate). However, gross margin stood around 60.5% year-to-date, below our 62% full-year expectation and 63.9% in the prior year period. We expect these factors will largely offset one another as we adjust our annual expectations and therefore don't foresee a material change to our $48.50 fair value estimate outside of the time value of money, which should add a couple of dollars to our valuation. We're holding steady on our longer-term outlook, which calls for around 10% average sales growth and low-60s gross margin (versus a 59% five-year historical average). While shares fell around 7% after market we'd suggest investors wait for a larger margin of safety.

During the earnings call, management mentioned the relationship between Monster and The Coca-Cola company restricts the latter from competing in the energy drink category, but with certain exemptions, and suggested Coca-Cola has developed two products that it believes may fall under these exemptions. At present, we don't expect this development to have a material impact on our valuation, as the proposed launch of these products has been suspended until April 2019 and the issue was submitted to arbitration last week. From our vantage point, this reflects the outsize bargaining power Coca-Cola has over Monster, as Monster's ability to secure shelf space and distribution is contingent on its relationships within Coca-Cola's vast bottling network, and supports our contention that this dynamic constrains Monster's competitive edge.