Dr Pepper Snapple Group finds itself underneath the money tree these days.
For years, a large proportion of the company's drinks have been distributed by PepsiCo and Coca-Cola bottlers, as well as by its own system and smaller third-party bottlers.
The recent moves by Coca-Cola and PepsiCo to buy out their biggest U.S. bottling partners triggered negotiations that will likely dump over $1 billion in Dr Pepper Snapple Group's lap. That's because the two beverage giants want to keep Dr Pepper Snapple's brands in their distribution system, as they can drive up sales of the colas with which they share shelf space.
But it will cost them. PepsiCo's takeover of its two biggest bottlers triggered a change-of-control provision and a $900 million payment to Dr Pepper Snapple. Coca-Cola and Dr Pepper Snapple are negotiating now over the brands currently distributed by bottler Coca-Cola Enterprises. Coca-Cola wants to continue carrying them. Analysts speculate Dr Pepper Snapple could reap $700 million or more in a deal.
It all makes for a heady time for Plano, Texas-based Dr Pepper Snapple, which is only a few years removed from being the unwanted stepchild of candy seller Cadbury Schweppes.
"All the stars are just lining up for these guys at the moment," Morningstar analyst Phil Gorham said recently, as Wall Street buzzed with expectations of Dr Pepper Snapple's potential payout from Coca-Cola.
With about one-sixth of the U.S. carbonated soft drinks market, Dr Pepper controls some of the few soft drinks that enjoyed bigger volumes last year. .The Dr Pepper brand is especially strong throughout the southwestern and southern states such as Texas.
It has become, in effect, the swing voter of the beverage industry.
"Our brands continue to gain relevance and are growing," Chief Executive Officer Larry Young told analysts and investors last month.
Now, the question is: Will the good times last?
Dr Pepper Snapple is a distant third-place player in the nonalcoholic beverage market and does not enjoy the economies of scale of Coca-Cola and PepsiCo, said Gorham. In addition, more than 90 percent of the company's net sales come from the U.S. Sales are heavily weighted towards carbonated soft drinks, a category that has been shrinking for years.
"A lack of exposure to international markets and other fast-growing beverage categories concentrates its business risk and will hinder the firm's ability to generate above-average, long-term growth," Gorham wrote last month. He said first-quarter results showed signs of a slowdown, as net sales slid 1 percent and profits fell by a third.
The company outperformed its U.S. beverage peers over the past year with a mix of hard work and good luck, Credit Suisse analyst Carlos Laboy wrote recently. But in the long run, Laboy said it could be a mistake for Dr Pepper Snapple to take cash payments instead of slowly retaking control of its beverage distribution and doing more it itself.
Laboy said Dr Pepper Snapple is apparently abandoning its one-time goal of becoming more "integrated" with the bottling operations that make its beverages. By contrast, Coca-Cola and PepsiCo are trying to exert more control over bottling. If the decision to let Coca-Cola and PepsiCo handle so much of Dr Pepper Snapple's beverages approach dings its brands' performance, the decision could come back to haunt the company.
Cadbury Schweppes in 2008 spun out Dr Pepper Snapple as an independent company. At the time, it was saddled with a legacy of a battered Snapple brand, big cost pressures and eroding soft drink consumption, among other issues, said Laboy.
Now, the company is trying to make a big splash. It added almost 4,500 coolers and vendors in the first quarter, and it plans to boost marketing spending by $25 million in the current quarter. The company last winter repaid $405 million of debt, repurchased $202 million in common stock and predicted that sales will rise between 3 and 5 percent this year.
The company's stock is up 64 percent over the past 12 months.
"You’ve got a management team that’s very focused," said Stifel Nicolaus analyst Mark Swartzberg. "There’s real money behind that focus."
Gimme Credit bond analyst Craig Hutson noted that Dr Pepper Snapple has repaid $1.4 billion in debt since then.
The company fared well in a difficult North American beverage market last year, stemming partly from the rollout of Dr Pepper Cherry and the expanded distribution of Crush through the Pepsi bottling system. Dr Pepper Snapple grabbed a point of U.S. market share in the first quarter of 2010.
While some analysts question the strategy, Dr Pepper Snapple's practice of splitting its allegiance between Coca-Cola and PepsiCo for distribution gives the company leverage, industry insiders said.
"It is a very important brand," said John Sicher, editor of Beverage Digest. "Years ago, Dr Pepper's franchise model was to pick the best bottler in a given territory. That has worked well for decades and has been partly responsible for the brand's growth from a regional soft drink to a major national brand."
The Dr Pepper brand, one of the strongest performers in the soft drink market last year, accounts for about one-third of the company's volume.
Dr Pepper Snapple Group outperformed the shrinking carbonated soft drinks category in 2009, beating the much larger PepsiCo and Coca-Cola. But in the long-term, growing by bucking a trend will not be easy, said Sicher. The company needs to grow its portfolio of non-carbonated beverages. Few large non-carbonated brands are for sale in the U.S. today, so growth has to come from existing brands, Sicher said.
Snapple, one of the company's main non-carbonated brands, has been bounced among multiple owners in the past decade and a half. Although it staged a surprise turnaround in the first quarter, with 17 percent growth, the company has work to do to get the brand on solid footing.
"It's important to not lose sight that they don't really have a foothold in the growth areas," said Gorham.
Market share of top carbonated soft drinks companies, 2009 (Source: Beverage Digest)
1) Coca-Cola Co. (41.9 percent)
2) PepsiCo (29.9)
3) Dr Pepper Snapple (16.4)
Others (11.8)
Market share of top 10 carbonated soft drink brands, 2009 (Source: Beverage Digest)
1) Coke (17 percent)
2) Pepsi-Cola (9.9)
3) Diet Coke (9.9)
4) Mountain Dew (6.7)
5) Dr Pepper (6.1)
6) Diet Pepsi (5.6)
7) Sprite (5.5)
Diet Mountain Dew (1.9 percent)
9) Fanta (1.8 percent)
10) Diet Dr Pepper (1.8 percent)
Key brands from Dr Pepper Snapple Group
Snapple, Mott’s, Hawaiian Punch, Yoo-Hoo, Country Time, Nantucket Nectars, Dr Pepper, 7UP, Sunkist soda, A&W, Canada Dry, Squirt, RC Cola, Welch’s and IBC.
