Exploring the Soda Pain Point

Chris Versace
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Posted: Oct 06, 2014 12:01 AM

Earlier this week, following the Clinton Global Initiative, Coca-Cola (KO), PepsiCo (PEP) and Dr. Pepper Snapple Group collectively announced a move to reduce the “number of beverage calories per person” nationally by 20% by 2025. Now, that doesn’t mean the companies are altering their beverages, even though they are doing that as well, but rather that they will be selling smaller soda portions – think 10-ounce cans instead of ones containing 12 ounces — and bringing more alternative beverage products (water, juices and so on) to market.

At a time when headlines are filled with the toll of rising obesity rates and the impact not only on the population’s health, but also the rising costs associated with it, consumption of both regular and diet soda has been falling. Sales of non-diet soda have fallen by 15% since 1998, given the shift toward lower-calorie diet beverages, but more recently, sales of diet soft drinks also have started to decline. The combined effect is resulting in overall soft drink volume declines like the one evidenced in PepsiCo’s June quarter results – its North America, non-carbonated beverage volume grew 1% and carbonated soft drink volume declined 2%.

With carbonated soft drinks accounting for significant pieces of revenue at Coca-Cola, PepsiCo, Cott Corp., Dr. Pepper Snapple and others, these companies are facing a pain point, plain and simple. We’ve seen them take steps to diversify their beverage portfolio, but even so, carbonated drinks still account for a meaningful portion of overall revenues and profits at these companies.

Pain points such as this one can overlap with replacement demand. By that, I mean replacing sugar, aspartame (think NutraSweet and Equal) or other artificial sweeteners with newer or “better” ones, like stevia-based solutions (SweetLeaf, Truvia or Pure Via). Coca-Cola is doing just that with its new Coca-Cola Life product that uses a combination of sugar and stevia.

As beverage companies look to reformulate their products, consumers are not likely to suffer a change in taste or flavor. Coca-Cola learned that lesson back when it introduced New Coke in 1985 and faced consumer backlash so intense the company was forced to bring back Coke Classic. This development towards changing ingredients while maintaining flavor has me circling in on flavoring companies like International Flavors & Fragrances (IFF), Stepan Company (SCL), Symrise AG (SYIEVY), Givaudan SA (GVDNY) and Senomyx (SNMX).

Each of those companies serves a number of markets, including the global beverage market, but the one that has caught my eye is Senomyx, largely given the company’s comments that it expects either PepsiCo or Firmenich SA to commercialize its proprietary sweet-taste modifier Sweetmyx S617 in 2014. Now, I’ve seen the horror of a company touting design wins that ultimately do not become revenues in the past, and that makes Senomyx a stock story that, in my opinion, requires far more diligence. Meanwhile, International Flavors & Fragrances shares are 10% off their 52-week high and trading at 18.8x and 17.3x consensus 2014 and 2015 earnings-per-share expectations, respectively. For context, which always is key, IFF shares peaked at 18x and bottomed at 14x calendar year earnings on average during the 2010-2014 period. Applying that to 2015 expectations that, at least for now, have IFF delivering earnings of $5.49 per share implies upside to $100 and downside to $77.

Now, that’s just one metric, and we need to look at more than just one. Because IFF has been a dividend dynamo – my name for a company that increases its annual dividend year in and year out – looking at historical dividend yields makes sense. Applying the same analysis over the same time period, we find IFF shares have upside to $108 and downside to $88 if the company increases its quarterly dividend to $0.50 in 2015, up from the current $0.47 per share. While that upside-downside may interest some, my preference is to see net upside of better than 20% in shares in order to get behind them.

My preference is to invest in companies that have favorable tailwinds that reflect the intersection of the current economic, demographic, psychographic, technological and regulatory landscapes, as well as those that are on the horizon. If you’re of the same mind,come join us.

In case you missed it, I encourage you to read my e-letter column from last week about Alibaba’s IPO and its effect on the Chinese and global markets.