Dr Pepper Snapple Lacks Fizz

By Ryan C. Fuhrmann | March 20, 2009 AAA

Shares of Dr Pepper Snapple (NYSE:DPS) jumped considerably after a favorable earnings report in late March. Even with the run-up, the shares still trade at about 10x earnings, which looks like a good deal considering the company owns a number of leading soft-drink and other beverage brands in North America. However, these aren't the only factors to consider.

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Current Results
Fourth-quarter sales were essentially flat, coming in at $1.4 billion as the loss of distribution rights for Glaceau, which was recently acquired by Coca-Cola, and Hansen Natural (Nasdaq:HANS) products were offset by a 1% increase in sales volume and price increases. Overall, higher cost-consciousness by consumers contributed to a predictable outcome in Dr Pepper Snapple's product volume trends. Volumes fell 7% for the premium Snapple brand, while more affordable carbonated soft-drink brands such as 7UP, Sunkist, A&W and Canada Dry (the company's "Core 4" brands) posted flat volumes. The "value-priced", non-carbonated Hawaiian Punch brand witnessed a strong 19% increase.

Bottom-line trends were difficult to discern as several one-time, non-cash charges pushed Q4 and full-year earnings into negative territory, but full-year cash flow from operations increased 17.6% to $709 million. Subtracting out $304 million in capital expenditures resulted in free cash flow (FCF) of $405 million, or $1.59 per share based on year-end diluted shares outstanding. Most of this was used to pay down the company's heavy debt load. (Read The Essentials Of Cash Flow to learn how to tune out the accounting noise and see whether a company is generating what it needs to sustain itself.)

Outlook
For the coming year, management expects sales to grow about 2 percent when excluding the loss of the Hansen product distribution, and it projects earnings between $1.59 and $1.67 per share. Again, free cash flow will be targeted on debt reduction, which stood at $3.5 billion as of year end.

Bottom Line
Dr Pepper Snapple's core brands are known for stable sales and profits, which is an enviable position to be in during economic downturns. Its stock is also very reasonably valued on a forward P/E and trailing P/FCF basis. However, debt will take many years to pay down, and the firm was left with mature brands and markets when it was spun off from Cadbury (NYSE:CBY) last May. And unlike Coca-Cola (NYSE:KO) or PepsiCo (NYSE:PEP), Dr Pepper Snapple owns many of its bottling and distribution businesses. These functions tie up capital and leave less to return to shareholders.

In other words, despite the favorable valuation and stable business outlook, Dr Pepper Snapple has too many obstacles to overcome to consider adding it to my stock portfolio.

Check out our Investment Valuation Ratios Tutorial to learn what to look for when picking your stocks.

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