If you have heard of Taurine, Guarana, and Gingko Biloba you most likely know about the fastest growing segment in the beverage market – energy drinks. The U.S. market for energy drinks has seen huge growth in the last five years with annual sales burgeoning from less than over $200M in 1998 to $1.1B in 2004. As the chart below illustrates, the industry's total sales slope looks like something you might find in Aspen, CO.


Currently there are hundreds of products in the space sold by dozens of companies all jostling for position in the rapidly growing market. Likely the most well known and well established player in the market is Red Bull (a privately held firm) who's innovative marketing strategy has led to huge success.

Red Bull may very well be in a class all of its own in this market. Years of brand building are not the least of which to blame. For this reason Red Bull will not be the focus of this piece.

However, there are some pretty loud footsteps knocking at the energy drink market's door.

Two names - Coca-Cola (KO) and PepsiCo (PEP).

So who should be the most worried about two of the beverage industry's heaviest hitters wading into the market? I would suggest Hansen (HANS), one of the only publicly traded pure plays in the market. Hansen markets its energy drinks under such brands as Monster, Blue Sky, and Junior Juice.

Both Coke and Pepsi have taken notice of this lucrative market and want a piece of the action. Currently Coke sells Full Throttle and distributes Rockstar Energy Drinks. Pepsi sells SoBe Energy Drinks.

Frankly, I am skeptical about a company like Hansen's continued success for two main reasons.

Coke and Pepsi are so ingrained in the beverage market it is nearly impossible to imagine them not existing. In my mind, much of their success is attributable to two major factors - brand recognition and low distribution costs. It is these two factors that they have leveraged in the past and it is these two factors that I believe they will leverage in the future. My predicted result? The proverbial giants will grab the lion's share of the energy drink market away from smaller companies like Hansen.

Keeping distribution costs low is one factor that enables both Coke and Pepsi to maintain healthy profit margins in the traditional beverage market. Obviously these well established distribution channels are transferable to the energy drink market. Additionally, as we all know, both Coke and Pepsi spend a tremendous amount of money each year promoting and reinforcing their brands. I do not see why their proven aptitude towards marketing and increasing brand recognition cannot be used to sell energy drinks.

If Coke and Pepsi are able to transfer the success they have experienced in more traditional beverage markets to energy drinks the competitors in this space should be worried.

As the energy drink market continues along in its life cycle moving from the rapid growth stage to a more mature one, competition becomes the name of the game. In other words it's likely the easy money has already been made and now competitive advantages reign supreme.

Please don't get me wrong, Hansen has enjoyed great success as the industry has grown and has done a lot of things along the way very well. Look no further than their sales which have more than doubled from $110M in 2004 to a projected $250M in 2005. The company's stock price has done alright too - since the start of 2004 the company's shares have risen from $4.14 to a split adjusted $44.79 (Oct. 11/05) – the elusive ten bagger! (Congrats to anyone who enjoyed in this phenomenal gain). But my focus in on the future and the company's ability to continue to add shareholder value.

Currently the energy drink market is one of extremely high profit margins compared to traditional soft drinks. Based on estimates by Credit Suisse First Boston gross profit margins on a case of energy drinks are eight times as high as a case of soft drink. However, as the industry matures and competition heats up pricing pressures are almost certain to squeeze margins.

Moreover, right now most sales are largely made in convenience stores and are purchased for immediately consumption. These sales channels typically have higher profit margins than non-convenience based markets (bulk stores). If the point of sale trend for energy drinks were to shift towards the bulk stores, including places like Costco (COST), Target (TGT) and Wal-Mart (WMT) it would lead to less attractive margins.

One needs to be careful when considering a potential investment in Hansen. Attention needs to be placed on the two giants that they competes against in the market. If Coke and Pepsi continue to viciously compete in this space (and I can't see why they wouldn't) Hansen and their shareholders will likely be the losers. Remember that as an industry moves out of the rapid growth phase to the mature phase competitive advantages reign supreme and in that battle my money is on Coke and Pepsi.

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