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Morningstar | Monster Sales Trajectory Remains Solid, but Unfavorable Mix Weighs on Margins; Shares Expensive

Monster Beverage posted annual results that largely aligned with our expectations, with net sales growth of 13.0%, operating margin of 33.7%, and diluted earnings per share of $1.76 near our estimates of 12.5%, 34.3%, and $1.77, respectively. As we had expected, input cost inflation (particularly for aluminum cans and freight) and an unfavorable shift in mix (from both a product and geographic perspective) compressed profitability, with full-year gross margin contracting 320 basis points to 60.3% (below our 61% expectation and the 63.5% annual level in 2017). We expect to lift our $50 fair value estimate by around 4% as we incorporate these results, but are holding steady on our longer-term outlook, which calls for around 10% net sales growth and mid-30s operating margin on average over our forecast. We'd suggest investors wait for a more favorable entry point, especially in light of a mid-single-digit uptick in shares on the announcement.

Fourth-quarter results reflected continued top-line momentum (with net sales up 14%, a slight acceleration from the 12% rate in the prior two quarters) and improving pricing and profitability trends, with average net sales per case of $9.43 representing a 1.3% increase over the prior year period (on a full-year basis, average net sales per case declined 1% to $9.21) and operating margin expanding 20 basis points to 33.2%. This was largely due to an increase in domestic selling prices and decrease in promotional activity as a proportion of gross sales. From our vantage point, Monster's ability to take pricing while maintaining a solid trajectory of growth (we estimate domestic sales grew by a high-single-digit percentage in the fourth quarter) is evidence of a brand intangible asset, which forms the basis of our narrow moat rating. We were also pleased to see better leveraged selling (down 230 basis points to 11.3% of sales) and general and administrative (down 40 basis points to 11.5% of sales) expenses.

We expect the company will continue to flex pricing in the U.S. to bolster profitability as international markets (which tend to have lower gross margin) become a more significant contributor to mix. These regions contributed around 30% of sales during the quarter, and we forecast this proportion to exceed 37% by 2023 as Monster's geographic footprint expands thanks to distribution through the Coca-Cola bottling network, which we think will support double-digit international sales growth over our forecast period. In this context, while we're impressed by 74% constant currency growth in Asia Pacific, we note that gross profit in the region stood around 46%, well below the 60% rate for the consolidated firm.

Strength within the Monster Energy segment (92% of sales; 15.9% net sales growth) also had an unfavorable impact on mix, as the Strategic Brands segment (7% of sale; 5.4% decline in sales) faltered, given that the latter's asset-light concentrate model is inherently higher-margin. Operating margin in the Strategic Brands segment stood around 58% in 2017, versus 42% for the Monster Energy segment. In tandem, we expect an ongoing shift in both product and geographic mix to keep a lid on gross margin expansion beyond the low-60's.