There Still Is Some Upside Left in Dr Pepper Snapple Group Inc. Stock

Dr Pepper stock - There Still Is Some Upside Left in Dr Pepper Snapple Group Inc. Stock

Source: Mike Mozart via Flickr (Modified)

At the end of January, Dr Pepper Snapple Group Inc. (NYSE:DPS) and Keurig Green Mountain, Inc. announced that the two beverage companies were going to merge into one beverage giant that could compete at scale with the likes of PepsiCo, Inc. (NASDAQ:PEP) and The Coca-Cola Co (NYSE:KO). It was big news that sent Dr Pepper stock flying higher.

On the day of the announcement, Dr Pepper stock jumped from $95 to $118. DPS stock has been somewhat stuck in neutral ever since then. It has bounced as high as $120. It has fallen as low as $114. But overall, Dr. Pepper stock has seen little net change over the past several months. Today, it sits right at $118.

If that sounds like an unexciting investment opportunity, that is because it is rather unexciting. No matter which way you slice it, there isn’t much upside left in DPS stock.

But there is still some upside. Again, no matter which way you slice it, DPS stock looks undervalued to me here. I see anywhere from 2% to 8% upside from current levels.

Here’s a deeper look.

Why Dr Pepper Stock Is Worth Between $120 and $130

In the DPS-Keurig merger, DPS shareholders get $103.75 per share in cash plus 1 share of Keurig Dr. Pepper (or KDP) stock. The $103.75 is locked and loaded. Therefore, the question mark in how much Dr Pepper stock is worth depends on how much KDP stock is worth.

By my analysis, KDP stock is worth somewhere between $17 and $24. That would mean DPS stock is worth somewhere between ~$121 and ~$128.

I largely subscribe to the opinion of Michael Lindsell, co-founder of London-based Lindsell Train and the ninth largest shareholder of DPS. I don’t really see many top-line synergies in a deal that merges a cold-drink company with a hot-drink one.

The combined entity does have more scale and presumably better distribution to compete more on par with KO and PEP. There will also be some overlapping costs which can be cut out.

But outside of that, I don’t see many benefits to this new KDP company. As such, I fully expect KDP’s revenue growth to look like a mix of revenue growth from DPS and Keurig. Same with margin growth excluding synergy-driven savings.

Keurig has seen its revenues decline by roughly 3% per year over the past several years. Meanwhile, DPS has seen its revenues rise by roughly 3% per year over the past several years. DPS will comprise roughly 60% of KDP’s combined revenues, so growth should still be positive. But we are talking about revenue growth in the 0-2% range.

Margins are trending higher at Keurig, and this should help offset the slower revenue growth. But overall, KDP earnings growth excluding synergy-driven savings should look very similar to DPS earnings growth.

In totality, the growth profile of KDP will be a lot like the growth profile of DPS. As such, the two should trade at similar valuations.

DPS, KDP and Earnings

DPS stock has historically averaged a 20-times trailing earnings multiple and 2.5% dividend yield. Pro-forma earnings for KDP, including all the synergies, were $1.27 per share in 2017. The annual dividend on KDP is expected to be $0.60 per share.

If you take the historical averages on DPS, then KDP stock is worth somewhere around $25.40 (20-times multiples on $1.27 EPS) or $24 (2.5% dividend yield on $0.60 dividend). Taking the lesser of those, I think KDP stock could reasonably be worth $24.

But KDP stock could trade at a discount to Dr Pepper considering the huge initial overhang of debt. The highest the dividend yield ever got on DPS stock over the past 5 years was roughly 3.2%. Say KDP stock trades with a 3.5% dividend yield. A 3.5% dividend yield on a $0.60 dividend gets you to a price target of roughly $17.

All in all, I think KDP stock is worth somewhere between $17 and $24. Adding that back to the $103.75 per share cash offer, you get to a value on DPS stock of between $120 and $130.

Bottom Line on Dr Pepper Stock

The stock has been rather uninteresting since the merger. But as it languishes around $118, DPS stock is undervalued.

If you’re looking for mild gains with significant downside protection, DPS stock could be a good investment idea for you.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2018/03/still-upside-left-dr-pepper-snapple-group-inc-stock/.

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