Keurig Dr Pepper: La Colombe Investment a Good Start, but Not Moving the Needle on Fair Value

We don’t expect to change our $34 fair value estimate for narrow-moat Keurig Dr Pepper KDP following its announcements of long-term distribution agreements with premium coffee maker La Colombe in conjunction with a $300 million equity investment for a 33% stake in the firm. Specifically, Keurig Dr Pepper will distribute La Colombe-branded ready-to-drink coffee starting in late 2023 and manufacture and distribute K-cup pods for the brand in 2024 onward. While we believe the agreement and equity investment make strategic sense, the bump to earnings will likely remain immaterial over the next several years given strong entrenched players in the coffee aisle and the small size of La Colombe. We continue to view shares as fairly valued, and our Standard Morningstar Capital Allocation Rating remains in place.

We hold a favorable view on the distribution agreements, which gives Keurig Dr Pepper exposure to the $6 billion ready-to-drink coffee category that it does not participate in and complements the firm’s soft drinks portfolio. Moreover, adding La Colombe to its K-cup ecosystem should further reinforce Keurig Dr Pepper’s dominance and expand the range of options for K-cup consumers encompassing premium, midrange, and value offerings. However, we expect incremental volumes from La Colombe to be small, given the brand’s current market share (under 2% in ready-to-drink coffee, versus top wide-moat player Starbucks at 62%) and a lack of presence in K-cups. To drive demand for La Colombe, we think Keurig Dr Pepper will have to invest in these channels in the coming years to drum up support from retailers and garner interests from consumers, thus our muted expectation of benefits on the bottom line. The equity investment is consistent with our projection of disciplined tuck-in deals, and valuation looks reasonable at 3 times estimated 2024 La Colombe sales (per management disclosure), in line with the multiple on Keurig Dr Pepper.