Portfolio Review: Dr. Pepper Snapple Group

I made an investment in Dr. Pepper Snapple Group (DPS) in June 2013 at $46.37 per share. The shares are up 30% since then, which is a much higher return than I would have expected in a year. Valuation was key to the original thesis, so I thought now would be a good time to revisit the company.

Company: Dr. Pepper Snapple Group (DPS)

Investment Thesis: Dr. Pepper Snapple Group is (1) a great business with a stable, repeating revenue base (2) at an attractive valuation. (3) The Company strategy to return capital to shareholders is also very attractive.

 (1) Great business model with stable revenues: The Company is focused on the flavored non-alcoholic beverages category and owns several well-known brands such as 7up, Canada Dry, Dr. Pepper, Mott’s apple juice, Orangina and Snapple. One of the things I love about this Company is that it is not chasing after fads in the market. Case in point is that they do not have an energy drink offer (which some analysts ‘fault’ them for). That means less growth and ‘excitement’ about them, but I see their revenues as much higher quality. People who drink Canada Dry, have it as part of their routine–nobody walks by a display of drinks, sees a Canada Dry and thinks “oh, some ginger ale sounds lovely!”. You get the Canada Dry because you were looking for some Canada Dry. Chances are you have even bought it there before.

Revenues are have been remarkably steady around $6bn and expectations are of sub 2% growth (Source: Company filings and analyst reports). I think it is encouraging that volumes have been quite steady as well, so this is not a case of price increases making up for lost volumes. I am not expecting this to change going forward, but I will say this: I like the idea that if revenues grow any faster for whatever reason (a core brand that was out of fashion comes back in vogue, a new market getting traction), they have a good chance of remaining at the higher level. Generally speaking, I expect revenues to grow with inflation, which is one of the great things about investing in a business, rather than a fixed income instrument.

Perhaps the one area where there is most room to grow is in Latin America Beverages. This segment has been growing at a nice rate and represents a real opportunity to ride the rise of a consumer class in those economies. ultimately, however, it represents only about 8% sales today, so it will be a while before it is a meaningful contributor to earnings.

(2) Valuation: Shares have traded up significantly since my original investment, so I want to be especially crisp about my view on the current valuation. Some key data points:

TEV / LTM EBITDA: 10x

TEV / LTM EBIT: 12x

P / LTM EPS: 17x

I think these are acceptable multiples for high quality business like DPS. I am not expecting to make enormous returns out of this investment, but rather a reasonably consistent, inflation protected return of 5-10%. At current valuations (earnings yield of 6%) it may be reasonable to assume that it may be closer to the bottom of this range.

One other things I find encouraging is that Depreciation & Amortization has been running ahead of Capital Expenditures (which are modest) for some time. This should provide some EPS tailwind over time as D&A normalizes:

D&A and CapEx (Source: Company Filings and CapitalIQ)
D&A and CapEx (Source: Company Filings and CapitalIQ)

While overall fundamentals about the Company have not moved dramatically over the last year, it’s share count has decreased by almost 5% as a result of share buybacks (source: Company filings). While multiples have expanded slightly, that has been combined with healthy a combination of share buybacks and some fundamental improvements/business growth to deliver capital returns over the last year. This combined with a healthy and increasing dividend (yield: 2.7%) makes for good shareholder returns, which brings me to:

(3) Returning capital to shareholders: It is quite rare to see a company with such a clearly stated strategy to return capital to shareholders. It takes a particular kind of manager to be both good at running a large business efficiently and humble enough to think that the business is big enough, and its returns belong to the shareholders. The Company’s management constantly reiterates its commitment to return excess cash to shareholders and has been doing so efficiently with mix of dividends and share repurchases for years. CEO Larry young once said: “We aren’t the biggest, but we tell people what we are going to do and we do it. We generate a lot of cash and give it back to shareholders.” I like that attitude. Looking at the numbers, this commitment comes through.

Cash flow from Operations and major uses of cash over 5 years (Source: Company Filings and CapitalIQ)
Cash flow from Operations and major uses of cash over 5 years (Source: Company Filings and CapitalIQ)

The spike in cash flow in 2010 is related to a large licensing deal signed with CocaCola and Pepsi that year. The additional cash was used to fund additional share repurchases in 2010 and subsequent years. Looking at 5 years cumulative sources and uses of cash provides a clear portrait of the Company’s strategy to return capital to shareholders:

5 years cumulative sources and uses of cash (Source: 2013 Annual report)
5 years cumulative sources and uses of cash (Source: 2013 Annual report)

The chart above is my favorite part of their annual report and illustrates one of the key reasons I think the Company is a solid investment for the long term.

Conclusion: The Company may not be particularly exciting, but it has a solid business and a great track record of shareholder returns. The current valuation is modest and should deliver a good return over a long time horizon. This is a great Company to own for 10 or 20 years. I would strongly considering adding to this holding if the price drops significantly, but for now I will hold on to the shares I own.

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