Who Knew Dr Pepper Snapple Group Inc. (DPS)’s Returns Were This High?

The Coca-Cola Co (NYSE:KO) has a market cap of $172 billion. PepsiCo, Inc. (NYSE:PEP)’s market cap is $136 billion.

By comparison, Dr Pepper Snapple Group Inc. (NYSE:DPS) is tiny.  The company has a market cap of ‘just’ $14.7 billion – less than one-tenth the size of Coca-Cola. Cedar Rock Capital invested one quarter of its assets in the stock and owns a large percentage of Dr Pepper’s outstanding shares. DPS is also very popular among quant hedge funds. AQR Capital, Renaissance Technologies, and Gotham Asset Management are among top 10 hedge fund holders. Interestingly short seller Jim Chanos also has a large position in the stock which indicates that the company is one of the best in its industry.

Unlike its larger rivals, Dr. Pepper Snapple Group does not have a global presence.  The company operates in the United States, Canada, Mexico, and the Caribbean.  In 2014, sales broke down geographically as follows:

• United States generated 88% of sales
• Mexico & the Caribbean generated 8% of sales
• Canada generated 4% of sales

The company’s smaller geographic area allows it to better focus its advertising messages and spending.  The United States is by far the company’s most important market.

Dr. Pepper Snapple Group was created in 2008 when the company was spun-off from Cadbury Plc.

Two well-known investors have positions in Dr. Pepper Snapple.  Mario Gabelli owns 1.9 million shares, and Joel Greenblatt owns over 500,000 shares.

Dr. Pepper Snapple Group Brands

The image below gives a quick glance of the company’s brands.

The company’s most recognizable brands include:

• 7 Up
• Sunkist
• Penafiel
• Snapple
• Clamato
• Dr. Pepper
• Canada Dry
• Schweppes’s
• A&W Root Beer
• Deja Blue water
• Hawaiian Punch
• Mott’s apple juice
• Crush Orange Soda
• Country Time Lemonade

Dr. Pepper Snapple’s most successful brand is Dr. Pepper.

The company also has its ‘Core 4’ consumer soft drink brands (shown below).

Growth Prospects

Dr Pepper Snapple Group Inc. (NYSE:DPS)’s revenue growth comes primarily though increasing market share of its primary brands.

The company accomplishes this through advertising spending.  Dr. Pepper Snapple Group has spent between $470 and $490 million each year on advertising in each of its last 3 fiscal years.  The company spends approximately 8% of sales on advertising.

Dr. Pepper Snapple’s earnings-per-share growth will come from a mixture of share repurchases, efficiency gains, and revenue growth.

Since the company’s spin-off, Dr. Pepper Snapple Group has reduced its share count at 3.8% a year.

Dr. Pepper Snapple Group has done much to increase efficiency and margins as well.  The company focuses on continuous improvement.  This has resulted in returns on equity growing from 18.0% in 2008 to 30.6% in 2014.

In total, Dr. Pepper Snapple Group has compounded its earnings-per-share at 10.3% a year since becoming a standalone company.

Recent results are in line with historical results.  The company grew adjusted earnings-per-share 14% in fiscal 2014.  Constant-currency adjusted earnings-per-share are expected to grow by around 10% in fiscal 2015.

Dr. Pepper Snapple Group is significantly smaller The Coca-Cola Co (NYSE:KO) and PepsiCo, Inc. (NYSE:PEP).  Despite being direct competitors with its two larger rivals, Dr. Pepper Snapple Group actually partners with them.  The following is taken directly from Dr. Pepper Snapple’s 2014 annual report:

“On February 26, 2010, we completed the licensing of certain brands to PepsiCo following PepsiCo’s acquisition of Pepsi Bottling Group and PepsiAmericas, Inc. The agreements have an initial period of20 years with automatic 20-year renewal periods and require PepsiCo to meet certain performance conditions. 

On October 4, 2010, we completed the licensing of certain brands to Coca-Cola following Coca-Cola’s acquisition of CocaCola Enterprises’ NorthAmerican Bottling Business and executed separate agreements pursuant to which Coca-Cola began offering Dr Pepper and Diet Dr Pepper in local fountain accounts and its Freestyle fountain program. The agreements have an initial period of 20 years with automatic 20-year renewal periods and require Coca-Cola to meet certain performance conditions. Under a separate agreement, Coca-Cola has agreed to include Dr Pepper and Diet Dr Pepper brands in its Freestyle fountain program. The Freestyle fountain program agreement has a period of 20 years.”

As you can see, the relationship between Dr. Pepper Snapple Group and its large rivals is far from heated.  Both PepsiCo, Inc. (NYSE:PEP) and The Coca-Cola Co (NYSE:KO) actually partner with Dr. Pepper Snapple Group in deals that are mutually beneficial for the companies involved.

Going forward, I expect Dr. Pepper Snapple to continue compounding its earnings-per-share at between 7% and 11% a year.  Growth will come from:

• Revenue growth (3% to 5%)
• Share repurchases (3% to 4%)
• Margin improvements (1% to 2%)

Dividends, Total Return, & Valuation

As noted above, Dr. Pepper Snapple Group returns large amounts of cash to its shareholders through share repurchases.

The company also has a shareholder friendly dividend policy.

Dr Pepper Snapple Group Inc. (NYSE:DPS) currently has a 2.5% dividend yield and a payout ratio of 48%.  The company’s payout ratio has hovered between 40% and 50% for much of its corporate life.

With large dividends and share repurchases, Dr. Pepper Snapple Group returns virtually all of its earnings to shareholders.  The image below shows the amount of cash returned to shareholders from 2011 through 2014:

Investors in Dr. Pepper Snapple Group can expect solid total returns going forward.  With expected earnings-per-share growth of 7% to 11% a year and a dividend yield of 2.5%, shareholders can expect total returns of 9.5% to 13.5% a year from Dr. Pepper Snapple Group.

Not bad for a ‘boring’ soda company.

Unfortunately, other investors have noticed that Dr. Pepper Snapple Group is a high quality business.

Dr. Pepper Snapple Group is currently trading for 20.1 times expected 2015 earnings.  The company is certainly not a value play.  Click here to see 11 undervalued blue-chips.

With that said, Dr. Pepper Snapple Group is likely trading around fair value for a high quality shareholder friendly business with a strong brand based competitive advantage.

Final Thoughts

Dr. Pepper Snapple Group is a shareholder friendly business with a strong portfolio of high quality brands.

The company operates in a slow-changing industry.  It is virtually impossible that consumers in North America stop drinking single-serve and fountain beverages.

It is very difficult to conceive of any technological changes that could ruin Dr. Pepper Snapple Group (unlike businesses in faster changing industries).

These characteristics make Dr. Pepper Snapple a suitable investment for dividend growth investors.  The company does not have a long dividend history due to its spin-off from Cadbury Plc.  With that said, many of the company’s individual brands do have a long history.

Dr. Pepper Snapple Group also performed well during the Great Recession of 2007 to 2009.  The company saw earnings-per-share grow each year through the Great Recession.  Click here to see the 10 most recession proof Dividend Aristocrats.

Dr. Pepper Snapple scores high marks for safety due to its presence in a slow changing industry, recession performance, and strong brands.

The company appears to be trading at fair value and offers investors above-average total returns.  Finally, the company’s management is shareholder friendly as well.

Disclosure: None