Soda’s Underdog Looks Undervalued: Dr Pepper Snapple Group Inc. (DPS), The Coca-Cola Company (KO)

When people speak of the Soda Wars, as many rightly do in the internet investment community and beyond, they are generally referring to PepsiCo, Inc. (NYSE:PEP) and The Coca-Cola Company (NYSE:KO), the world’s soft drink heavyweights that together control the lion share of carbonated beverages sold worldwide. Dr Pepper Snapple Group Inc. (NYSE:DPS), on the other hand, is usually relegated to the sidelines, the consumption of their flagship product left to a select group of soft drink connoisseurs who prefer something more exotic to quench their thirst. Their stock value has similarly lagged behind the popularity of the two main soda producers. Why is this underappreciated brand trading at a discount?

Dr Pepper Snapple Group Inc. (NYSE:DPS)Company Overview

Dr Pepper Snapple Group Inc. (NYSE:DPS) is responsible for producing the quirky tasting drink to which it owes half of its name, as well as a range of other beverages including Crush, Canada Dry, 7UP, Schweppes, YooHoo, AriZona and of course Snapple. The company has a market cap of $8.92 billion, which looks rather petite compared to The Coca-Cola Company (NYSE:KO)’s massive $173 billion and PepsiCo’s $118.18 billion. The stock has a laidback beta of .71 and is up just shy of 16% in the last twelve months. It also offers a handsome dividend yield of about 3.5%.

Valuations and Metrics

Dr Pepper Snapple Group Inc. (NYSE:DPS) currently trades at 14.8x TTM earnings, which is well below the industry average of 22.18. It’s also well below that of its main competitors, as The Coca-Cola Company (NYSE:KO) trades at 19.71x earnings and Pepsi at 19.53x. The price to sales of 1.49 paints a similar picture, lower than Coke’s pricey 3.6 and Pepsi’s 1.8. Could it be that the market has simply forgotten about the good Doctor?

Some commentators argue that there is something else afoot. They point here to the company’s somewhat sluggish sales growth, insufficient exposure to the faster growing drink segments, and inferior cash flow. Indeed, consumer awareness is shifting and many people are now going for the healthier beverage alternatives. However, Dr Pepper Snapple Group Inc. (NYSE:DPS) is still making some pretty good money despite these headwinds and is doing a fair job of returning this value to shareholders in the form of dividend increases.

Earnings and Dividend

The company served up EPS growth more or less on par with the industry in 2011 and 2012, after lagging slightly in 2009 and 2010. 2012 full-year EPS missed by 3 cents, but beat by 7 cents in 2011. The analyst consensus for 2013 EPS is $3.07, which represents a growth rate of about 5% compared to the previous year. The most recent earnings release painted a fairly poor picture of sales growth, with net sales up only 1% for the quarter although reported gross margins were up 50 basis points to 59.2%. As a result of these slowing sales and shifting consumer preferences, the company launched the TEN platform, which according to management delivers the “same great taste and mouthfeel” of regular soft drinks, but with far less calories. The company expects investments in this platform to top $30 million in 2013.

The company also announced a dividend increase of 12% in the Q4 report, which is the fifth increase since they went public. The stock now pays a quarterly dividend of $0.38. The dividend yield of 3.5% is above Coca Cola’s 2.9% and Pepsi’s 2.8%. Dividends have been increasing steadily for the last 3 years, and percentage increases have more or less kept pace with the industry.

Looking at the competition, recent earnings do seem a little better, although Dr. Pepper has the substantially higher expected growth rate. Pepsi has been outpacing the industry in terms of EPS growth for at least the last five years, and has beaten estimates since Q3 2011. On the other hand, the expected 3-5 year EPS growth estimate is only 5.7%, which is slightly under the soft drinks industry average of 6.4%. Dr. Pepper Snapple is looking at a 3-5 year estimate of 14.3%, and the 1 year EPS growth rate is also above the industry average. Coca Cola has had a mix of beats and meets in the last few years, but full-year EPS is growing steadily. The company has an expected 3-5 year growth rate of 8.2% and a 1 year growth rate of 6.2%.

Bottom Line

So, what’s going on with Dr. Pepper Snapple Group? They are clearly undervalued compared to their main competitors, the industry as well as the broader market. Yet, this valuation does also seem to echo slowing sales due to changing consumer preferences. The company is now trying to turn things around by focusing on lower-calorie alternatives, but it remains to be seen if they can keep up with their larger competitors.

The article Soda’s Underdog Looks Undervalued originally appeared on Fool.com and is written by Daniel James.

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