Dr. Pepper Snapple Bottling Further Upside

By Ryan C. Fuhrmann | April 03, 2012 AAA

Back in 2008, Cadbury Schweppes spun out Dr. Pepper Snapple (NYSE:DPS) to separate its confectionary business from the slower growing carbonated soft drinks (CSD) operations. Dr. Pepper's stock has performed well since it became its own company, beating both of its larger rivals and the market as a whole by a fairly wide margin. Its performance confirms that spinoffs can prove lucrative for investors, and there is potential for more decent returns going forward.

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Recent Financial Results
For 2011, sales rose 5% to $5.9 billion. Overall volumes declined 1%, but Dr. Pepper was able to push through price increases on some of its products and also saw a benefit from renegotiating distribution deals from PepsiCo (NYSE:PEP) and Coca Cola (NYSE:KO), due to their purchase of their domestic bottling operations. Its international bottlers, such as beer giant and Latin American Pepsi bottler Ambev (NYSE:ABV) and Coca-Cola Bottling (Nasdaq:COKE), continue to trade separately.

Higher product costs due to rising commodity costs for the key ingredients that go into making drinks, resulted in very modest gross profit growth of 1%. Management was able to reduce operating expenses as a percent of total sales, but a modest uptick in other expenses was enough to result in flat operating income of $1 billion. However, a loss related to retiring debt in 2010 allowed reported net income to rise roughly 15% to $606 million. Share buybacks helped boost earnings per diluted share by 26% to $2.74. Free cash flow came in at about $545 million, or roughly $2.46 per diluted share.

SEE: A Breakdown Of Stock Buybacks

Outlook and Valuation
For 2012, analysts project DPS modest sales growth of roughly 2.7% and total sales of approximately $6.1 billion. They expect earnings of $2.93 per share for annual profit growth in the neighborhood of 8%. At the current share price around $40 per share, the forward P/E currently stands at roughly 12.6.

Pepsi and Coke trade at forward earnings multiples of about 15 and 17, respectively, and arguably deserve a premium to Dr. Pepper, given they have more compelling sales growth prospects. Both are huge international players, while Dr. Pepper is primarily restricted to the North American market.

SEE: Parched For Profits? Try Beverage Stocks

The Bottom Line
Yet despite these top-line challenges, Dr. Pepper has performed admirably since its spinoff. It has reduced its debt/equity ratio from above 40 to 24% currently, and boosted profits by more than 22% since 2007. Free cash flow production has improved closer to 50%.

Management should be able to continue boosting earnings in the high single digits going forward. Combined with a current dividend yield of around 3.4%, which is ahead of both Pepsi and Coke, investors could garner low double-digit annual returns on their investment going forward; there is potential for valuation expansion, should Dr. Pepper figure out a way to gain exposure to more international markets.

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At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

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