It drives me crazy to see a company missing an obvious opportunity. This is exactly what’s happening with Monster Beverage Corp (NASDAQ:MNST). For a while, Monster had the chance to establish itself as a premier name in the beverage industry. With case sales up 20% or more, and earnings following suit, Monster Beverage Corp (NASDAQ:MNST) looked like a good opportunity. However, in the last several quarters, Monster’s management seems to have been caught flat footed.
Huge competition isn’t the company’s main problem
Many people would probably point to the size and scope of competitors like The Coca-Cola Company (NYSE:KO), PepsiCo, Inc. (NYSE:PEP), and even Dr Pepper Snapple Group Inc. (NYSE:DPS), as reason enough to avoid Monster Beverage Corp (NASDAQ:MNST). However, the biggest challenge facing Monster is the question of the health concerns related to their beverages.
While the company maintains that there is no connection between energy drinks and health issues, in the CNBC Morning Brief from March 22, this was called into question. According to this brief, the “American Heart Association” performed a, “study finding that energy drinks may increase blood pressure and disturb the heart’s natural rhythm.”
There is no question that individuals will consume what they want; after all, look at cigarette consumption. However, any concrete study finding problems caused by energy drinks will only put more focus on the safety of these beverages.
Promoting the brand and killing earnings
Another problem facing Monster Beverage Corp (NASDAQ:MNST) is something ironically they have 100% control over. The company routinely spends a significant amount of revenue on promotional expenses. In fact, this was a key factor in the company’s disappointing EPS growth of just 6.1% last quarter. I mentioned this as something investors should watch when the company reported earnings.
Unfortunately for Monster Beverage Corp (NASDAQ:MNST) investors, the company is making a bad habit even worse. Last year, the company spent 12.27% on promotional expenses. Last quarter, this promotional expense rose to 14.29%, and in the current quarter it stayed high at 13.49%. The company has to find a way to strike a balance between promoting the brand, and sacrificing profits.
Coca-Cola, PepsiCo, and Dr. Pepper Snapple know that promotional spending isn’t the best way to build a brand long-term. Each of these companies utilizes advertising to keep their brands in customer’s minds instead of cutting their profits by excessive promotional spending.
Organic growth that others would kill for
In the current quarter, Monster saw case volume jump 17.64%. In Coca-Cola’s last quarter, their sparkling beverage volume was up just 1%, and still beverage volume was up 9%. PepsiCo saw at best mid to low-single digit volume growth. Dr. Pepper Snapple saw full year sparkling and still beverage volume both decrease 5%.
Monster also has consistently reported mid-teen or twenty percent revenue growth, whereas their peers are lucky to report 5% to 8% revenue growth. However, between Monster’s promotional spending, and a 2.2% drop in price per case, net income was up just 5.34% compared to a 16.6% increase in revenue. In fact, the only reason EPS was up 10.6% was because of significant share repurchases. The bad news for Monster investors is these share buybacks aren’t certain to continue.
What’s the real value here?
I’m sure Monster investors were more than a little worried when CEO Rodney Sacks admitted, “the growth of the energy drink market in the United States has softened from previous quarters.” However, if they are looking for Monster to meet earnings projections, they should be more concerned about the company’s gross margin and share repurchases.
The combination of higher promotional expenses and lower per case pricing, contributed directly to Monster’s gross margin dropping from 52.3% last year to 51.7%. Relatively speaking, Coca-Cola’s gross margin of 59.60%, and Dr. Pepper Snapple’s margin of 59.23% both soundly beat Monster. Even PepsiCo’s gross margin of 51.62% is very close, though the company has lower margin businesses than Monster. If PepsiCo focused solely on beverages, their gross margin would be higher.
Lower margins are never a good thing, but Monster’s use of its cash and investments is even more troubling. Over the last year, Monster’s cash and investment balances have dropped from $793.81 million to $340.95 million. I would suggest this greater than 55% drop, argues heavily that the company won’t be able to continue retiring shares at the pace they did in the last year.
While none of the other beverage stocks look cheap relative to their growth rates, they all have dividends that should help prop up their shares. Coca-Cola pays a 2.79% yield, PepsiCo pays 2.76%, and Dr. Pepper Snapple pays 3.28%. It’s true that Monster’s projected EPS growth of 19% is far better than Coca-Cola at 8.95%, PepsiCo at 7.27% or Dr. Pepper Snapple at 5.85%, but will this growth occur?
I would argue that 19% EPS growth is likely out of reach for Monster. The company is heavily reliant on the U.S. beverage industry, and has admitted softer demand. Higher promotional spending, and curtailed share repurchases, will likely spell lower EPS growth. Investors need to temper their expectations for this Monster, or continued earnings misses might take a bite out of their portfolio.
The article 3 Reasons This Company May Continue Missing Estimates originally appeared on Fool.com and is written by Chad Henage.
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