One of the beverage industry’s best investments over the past several years has been Monster Beverage Corp (NASDAQ:MNST). Led by continued domination in the domestic energy drink market, global product expansion through a partnership with The Coca-Cola Co (NYSE:KO), and robust margin improvements, Monster stock has gone from $20 five years ago to $70 earlier this year.
But then tragedy struck in the company’s fourth quarter earnings report. Sales growth was tepid, coming in a multi-quarter low of 7.5%.
But the bigger negative was the company’s profitability profile. Gross margins fell back a whopping 400 basis points, and are expected to remain depressed into the foreseeable future.
What does that mean for Monster stock?
Nothing good. Because of its robust historical growth profile, Monster developed into a richly valued stock. But now that revenue growth is weaker than normal and margins are on watch, MNST looks overvalued.
Here’s a deeper look:
Monster Beverage Has OK Growth Prospects
The great thing about Monster Beverage is that this is a consistent and healthy growth company. Revenue growth has been north of 10% for several years in a row now while gross margins have expanded from 52% in 2013 to 63.5% last year.
But things aren’t getting better at Monster. On the top-line, things are getting somewhat weaker. On the bottom-line, things are getting substantially weaker.
Revenue growth won’t come off the rails any time soon. But it should be noted that the company reported three quarters of sub-10% revenue growth this past year. That is out of the norm for a company that has consistently posted revenue growth north of 10% for the past several years. Also, last year’s 10.5% revenue growth rate was a three-year low.
The company is still expanding its leadership in the energy drink category. Plus, the global expansion narrative is still a big growth driver. But, eventually, 80% growth in Brazil, 40%-plus growth in South Korea, 20%-plus growth in Oceania, and 20%-plus growth in Mexico and the Carribbean will come down.
When those markets become saturated and growth slows, MNST’s overall revenue growth rate will head lower.
Meanwhile, on the margin line, gross margins are being adversely affected by higher material costs and sales mix. It is unlikely that these headwinds reverse course in the near future. That is why management said on their most recent earnings call that gross margins are likely to remain flat into the near future.
In total, then, Monster Beverage stock is supported by a good, but not great, growth narrative that is becoming less and less exciting each quarter.
Monster Stock Isn’t Priced for Flat Margins
The problem with Monster stock is that it isn’t priced for the company’s growth narrative to become less exciting.
At best, the company’s 10% revenue growth rate persists over the next several years. Thus, revenues in five years should look something like $5.4 billion.
Margins are on watch, and gross margins are expected to be pretty flat into the foreseeable future. Nonetheless, 10% revenue growth should drive operating leverage in a five year window.
Over the past several years, operating margins have trended from 25% to 35% alongside robust gross margin expansion. Thus, over the next several years, operating margins should trend from 35% to 40% alongside more tempered gross margin expansion.
A 40% operating margin on $5.4 billion in revenues implies operating profits of under $2.2 billion in 5 years. Taking out 21% for taxes and dividing by 580 million shares, that equates to just under $3 in earnings per share.
A market-average growth multiple of 20-times forward earnings on $3 implies a four-year forward price target of about $60. Discounted back by 10% per year, that equates to a present value just over $40.
Bottom Line on Monster Stock
In the $50’s, Monster stock looks like it is priced for both healthy revenue growth and margin expansion to persist. Neither of those are terribly likely to happen. As such, MNST stock looks like a sell at current levels.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.