Growing Pains At Dr Pepper Snapple

By Ryan C. Fuhrmann | November 14, 2008 AAA

On May 7, Cadbury (NYSE:CBY) spun off its North American beverage operations to shareholders in the form of Dr Pepper Snapple (NYSE:DPS) shares, leaving Dr Pepper to gain its independence during what CEO Larry Young characterized as "one of the toughest environments the beverage industry has faced in many years". Yet despite the many bottles Dr Pepper is having to juggle these days, it appears to be making its way. (Companies use M&As and spinoffs to boost profits. Learn how you can do the same in Cashing In On Corporate Restructuring.)

Mixed Q3 Results
Third-quarter results released November 13 were mixed – Dr Pepper gained 0.3% market share in the U.S. carbonated soft drink (CSD) segment, according to ACNielsen. On the other hand, the pie continues to shrink as more health-conscious consumers shift to healthier, non-carbonated beverages and consumer spending suffers due to an overall economic slowdown. The same can be said for Dr Pepper's Canadian and Mexican operations, which are also being adversely affected by a strong U.S. dollar and lowered growth and profitability when translated back to the home currency.

To quantify the above, total reported Q3 net sales fell 2% to $1.5 billion on a 1% fall in volume. However, Dr Pepper lost Glaceau product distribution as the upstart drink firm was acquired by Coca-Cola (NYSE:KO) earlier this year. Excluding this loss, net sales grew 5% and volume improved 1% as management cited growing demand in flavored CSD, at the expense of traditional carbonated beverages sold by the likes of Coke and Pepsi (NYSE:PEP). Surprisingly, "premium-priced products" including tea, enhanced water and the Snapple brand performed below the company's expectations. Management cited slower spending even though these product categories have been taking market share from CSD product lines.

Strong Cash-Flow Generation
Dr Pepper also lost its product distribution agreement with Hansen Natural (Nasdaq:HANS), leaving another one-time item to ding profitability and a lower sales base to spread costs over. This pushed gross profit down 4% for the quarter while other restructuring charges left total reported earnings down 33% to $106 million, or 41 cents per share. Again, from a continuing perspective the profit hit wasn't as severe, and operating cash flow for the first nine months of the fiscal year improved to $582 million excluding the impact of certain items. When adding those items back, cash from operations year to date was still $523 million.

This strong capital generation allowed management to pay down the hefty debt load that Cadbury left behind by $295 million. That still leaves $3.6 billion in debt to whittle down, but it will boost earnings over time as interest expense becomes less of a burden. As it sits now, its mandatory repayment schedule for debt is $90 million for 2009, which leaves "lots of flexibility", according to CFO and Executive Vice President John Stewart. The fact that Dr Pepper can do this in a down economy speaks to the stability of its cash-flow generation. Additionally, there is potential to reduce costs, and during the earnings conference call Young alluded to being "all over" opportunities to realign the bottling group and cut other expenses.

Good Long-Term Potential
Ideally, Dr Pepper would be able to offload its bottling operations, much as Coca-Cola Bottling (Nasdaq:COKE) and Pepsi Bottling (NYSE:PBG) operate somewhat independently from Coca Cola and Pepsi, leaving the latter entities to focus on the higher-margin sales and marketing functions in the beverage industry. So, while Dr Pepper currently has its hands busy right-sizing its operations amid a challenging macroeconomic environment, it's hard to ignore its long-term potential as the third-largest soft drink player in North America.

Worried about these uncertain times? Read Guard Your Portfolio With Defensive Stocks.

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