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Look to Dr. Pepper Snapple for Dividend Growth Potential

Using Coca-Cola and PepsiCo to great advantage

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I view Dr Pepper Snapple Group’s management as very shareholder friendly ones. They are utilizing their steady cash flows to repurchase stock and regularly hike dividends. This is because it has strong brands such as Dr Pepper & Snapple, which have a fiercely loyal customer base. At some point however, I would like to see them expand by adding new products in segments it is not represented, and in other countries.

I also view the company as a very stable consumer staple, which has strong brand names that consumers like. I would say it has competitive advantages, and should continue to churn out plenty of free cash flows for the next 20 years.

The largest portion of revenues are derived from carbonated soft drinks. This segment is not particularly popular with investors, given the declines in consumption over the past decade, in addition to stagnant sales volumes expected due to health concerns by customers. The company is trying to be responsive by introducing low calorie beverages like Dr Pepper 10, 7 UP 10 etc. Given the stable nature of the business brands, I believe that the firm can achieve solid total returns for shareholders, even with anemic growth in the future. They are also increasing the amounts they are spending on advertising, in order to create buzz about the product and maintain the brand, which should bode well for revenues.

Dr Pepper Snapple Group does not have any energy drinks, nor does it have any bottled water to offer. This could be an opportunity for diversifying away from carbonated drinks, and could also provide the company with the ability to expand internationally. This could likely cost a lot of money however, which is why being smart with the shareholder money and not expanding at all costs would be preferred.

The company currently operates in mostly three countries – US, Canada and Mexico ( also Caribbean). This is because the company was acquired by Cadbury Schweppes in 1995. Back in 1999, the parent sold a large part of international distribution rights to Coca-Cola for 155 countries. As a result, the company would be unable to expand internationally, unless it buys back those licensing rights.

While the US represents half of the global soft drinks market, Europe is second at slightly over one-third. Asia Pacific represents about 12%, although it could result in higher growth over time.

Several months ago, DPS purchased the rights for distribution of Snapple in key markets such as China, Japan, Australia, South Korea, Malaysia, Hong Kong and Singapore. This is the right strategy to pursue, in order to capitalize on long-term growth in the emerging markets. The rights to Dr Pepper drink internationally are owned by Coca-Cola or Mondelez International (MDLZ).

The allure behind the growth story of Coca-Cola and PepsiCo is in the expected growth in emerging markets such as China, India, Russia, Brazil, Turkey and many others. As millions of consumers become middle class in those emerging markets, they would be able to spend their increasing discretionary incomes on items such as sodas, snacks and other purchased beverages.

Overall, I like that Dr. Pepper is shareholder friendly, and manages to distribute a lot of its excess cash flows to shareholders through dividend increases and share buybacks. However, I do not like the fact that the company is dependent on its main competitors Coca-Cola and PepsiCo for a large portion of its revenues and operating income. This is mitigated by its long-term licensing contracts with these two giants, and could be a positive because it provides a lot of cash flows with a limited need for a lot of capital to build a distribution system.

In addition, I do not like the fact that Dr Pepper Snapple group is limited to only a select few countries for its operations, and has to purchase this right with shareholder cash. The company is trying to create new healthier beverages, and to expand internationally, which could be very beneficial in the long run.

The reason why had not purchased Dr Pepper till this moment is because I was already invested in the largest two “soda” companies in the world – Coca-Cola and PepsiCo (although I realize that PepsiCo has a substantial snack operation, I am looking at it from a soda company perspective here). In addition, its operations are mostly limited to North America for legacy brands as it cannot expand abroad. The company does not have a long history of dividend increases, which is mitigated by the fact that it was listed for only five years.

At this time, Coca-Cola and PepsiCo are trading above 20 times earnings, which prevent me from adding money to those positions today. The stock of Dr. Pepper Snapple Group  is much cheaper at times earnings and yielding %. I also believe that the company would be able to grow cashflows and earnings well over the next 20 years, especially if it manages to expand in Europe, Asia – Pacific and South America.. Long-term growth of Dr Pepper Snapple over the next 20 -30 years would likely be slightly higher than that of its two largest rivals, due to its small relative size.

I recently purchased a very small starting position in the company, because I find it easiest to monitor an investment when you own it. It is difficult to find quality at a cheap price these days, which is why Dr Pepper Snapple Group sounded like an overlooked play. While I am not very happy with the reliance on Coke & PepsiCo mentioned above, or the lack of exposure outside of North America, and the heavy reliance on carbonated drinks, I think there is plenty of opportunity.

There is a strong brand name, and opportunities for very good total returns over the next 20 years through stable revenues and earnings, share repurchases and dividend growth. If the company introduces new products to compete in new niches, manages to expand internationally by tapping the cash cow business behind Dr. Pepper and Snapple brands, it can probably achieve a dividend champion status one day. Even if it simply uses excess cashflows to repurchase stock and raise dividends, Dr Pepper Snapple Group should do well for shareholders.

Full Disclosure: Long KO, PEP, DPS, MDLZ

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