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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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Dr Pepper Snapple Group (DPS) was spun off from Cadbury Schweppes in 2008. It initiated a dividend in 2009, and has managed to consistently raise it, while repurchasing stock.

Analyst expectations are for the company to earn $3.08 per share in 2013 and $3.29 per share by 2014. I initiated a positionin the stock in the prior week,

The company operates under three segments:

Packaged Beverages 

This segment is responsible for primarily manufacturing and distribution of packaged beverages and other products, including DPS brands, third party owned brands and certain private label beverages, in the U.S. and Canada. This segment accounts for approximately 73% of sales, but 40% of operating profits.

Latin America Beverages

The Latin America Beverages segment reflects sales in the Mexico and Caribbean markets from the manufacture and distribution of concentrates, syrup and finished beverage. This segment accounts for approximately 7% of sales, but 4% of operating profits.

Beverage Concentrated 

This segment is responsible for manufacturing and selling beverage concentrates to customers in US and Canada. Most of conentrates are produced in St Louis, Missouri, which is a risk in and of itself, in case of a natural disaster. This segment accounts for approximately 20% of sales, but 57% of operating profits.

One of the warning signs that I identified from reading the annual report was that 67% of Dr Pepper volumes are distributed through the Coca-Cola affiliated and PepsiCo affiliated bottler systems. I also found out that PepsiCo (PEP) and Coca-Cola (KO) are the two largest customers of the Beverage Concentrates segment, and constituted approximately 30% and 18%, respectively, of the segment’s net sales during 2012. The Beverage Concentrates segment’s operations generate a significant portion of the company’s overall segment operating profit.

On the other hand, using the distribution networks of Coca-Cola & PepsiCo bottling groups could be an advantage, because it could require less investment from Dr. Pepper Snapple Group’s part to build out those relationships. This could mean more money for shareholders either through higher dividends or share repurchases.

It is interesting that no one talks about this arrangement, as I could see a lot of issues arising from it. First of all, it looks like an arrangement where the wolf is put in charge of the herd. In other words, a potentially cancelation of one or both contracts could result in a 25% – 30% drop in profits for Dr. Pepper. In addition, failure to properly distribute Dr Pepper products in order to sell their own products, could be another scenario where Coca-Cola and Pepsi can steal market share away from the company.

In 2010, the company made 20 year licensing deals with PepsiCo and Coca-Cola that paid the company $900 and $715 million dollars respectively. As a result, it is recognizing $64.60 million in annual revenue over 25 years. The company used this cash for buybacks and debt reductions.

On the other hand, the 20 year contract with both companies might be too expensive to break by Coke or Pepsi, which could result in a relatively peaceful 18 years for DPS. In addition, I wouldn’t be surprised if either giant decides to try and acquire Dr Pepper Snapple, in order to tap into this cash machine. The only factor preventing this might be the US government’s distaste for monopolies. A cash rich private equity group however, might be able to do just that however. In addition, both agreements could very easily be extended for another 20 years around 2030, and they require that both PepsiCo and Coke meet certain performance conditions.

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