Less Thirst for Soda Doesn't Hurt All Soft Drink Makers

Adam Fleck: We've all heard about the health risks of drinking soda, and whether or not you agree with these claims, the fact remains that U.S. consumers are drinking less carbonated beverages. Per capita consumption rates have fallen at a low single-digit clip annually over the past 10 years, and we expect further declines of about 1% to 2% per year as people continue to leave the category. But we ultimately believe that overall value in the broader U.S. nonalcoholic soft drinks can grow at a positive rate going forward for two main reasons. First, noncarbonated beverages such as sports drinks and bottled water continue to climb at a healthy clip and have become large enough that we expect about 1% volume growth in total ready-to-drink beverages. Second, we expect pricing to remain rational and for manufacturers to continue to drive sales through smaller package sizes, which ultimately boosts price per ounce. In all, we forecast a low-single-digit total dollar growth for the U.S. soft drink industry over the remainder of the decade, per year. 

Our view has an outsize impact on Dr Pepper Snapple, which garners nearly 90% of its revenue from the U.S., and the vast majority of that from carbonated beverages. In addition, international expansion for the firm is limited by third-party ownership of its brands outside of North America and Mexico, leading to low top-line growth. Now, the firm has done a nice job expanding margins and free cash flow, and we ultimately remain confident in the company's narrow moat, but we also don't see the same level of improvement going forward given its already best-in-class performance. As a result, we expect Dr Pepper's long-term earnings growth will be considerably lower than either Coca-Cola's or PepsiCo's. The market doesn't seem to recognize this long-run potential downside, and we believe shares remain considerably overvalued.