Keurig Dr Pepper

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Keurig Dr Pepper is a North American beverage company that manufactures, markets, and distributes a diverse portfolio of branded beverages and single-serve brewing systems.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

KDP is a leading beverage company with a wide portfolio of brands and a strong North American presence. Let’s delve deeper to understand if they have a wide moat.

Business Overview

KDP operates through three main segments:

  1. U.S. Refreshment Beverages: This segment manufactures, markets and distributes branded carbonated soft drinks, juices, teas, waters, and mixers primarily in the United States.
  2. U.S. Coffee: This segment focuses on the manufacture, sale, and distribution of single-serve K-Cup pods, specialty coffee, and coffee systems in the U.S.
  3. International: This segment includes the manufacture, sale and distribution of beverage brands in Latin America, Canada, and other international markets.

Keurig Dr Pepper’s integrated business model in North America enables it to manufacture, sell, and distribute both hot and cold beverages as well as brewing systems.

Moat Analysis: 3/5

Intangible Assets

  • Brand Strength: KDP owns and manages a wide portfolio of well-known brands like Dr Pepper, Keurig, Canada Dry, 7UP, A&W, Sunkist, Snapple, Mott’s, and many other.

These brands hold strong customer loyalty and create a barrier to entry for new competitors. Brand recognition and trust are valuable intangible assets.

  • Proprietary Technology: The Keurig single-serve brewing system and K-Cup pods also constitute a proprietary product, which requires significant capital investment and technological know-how to replicate. While it faces competition, KDP has managed to maintain a strong market share.

Switching Costs

  • Consumer habits make it difficult to shift away from the convenience that K-Cups and Keurig brewers offer.

Cost Advantages

  • Distribution Network: KDP benefits from its extensive distribution network which gives an edge over smaller competitors by enabling it to reach many distribution partners.

Network Effect

  • The company does not have a strong moat based on network effect as it does not create a direct network for users to interact.

Moat Rating Justification

Based on their brand name, vast distribution network, scale and proprietary technology, and moderate switching costs, KDP achieves a moderate moat rating of 3. The intangible assets are real and make it a reliable company but it could be vulnerable to strong competitors (as seen in the coffee segment).

Risks to the Moat & Business Resilience

While KDP enjoys a decent moat, there are risks that can erode it over time, and here they are:

  1. Changing Consumer Preferences: The beverage industry is subject to shifting consumer tastes and preferences, which can quickly alter demand for different products. Health trends, sugar taxes and rising interest in healthier options may have an impact on KDP’s sales.
  2. Intense Competition: The beverage industry is intensely competitive, with many large and small players vying for market share. KDP faces competition from companies like Coca-Cola and PepsiCo which have a greater scale and better brand recognition. In the coffee segment, there is competition from Nespresso and other coffee pod makers. The entrance of private label and lower-priced alternatives can also hurt sales.
  3. Commodity Price Fluctuations: KDP is exposed to fluctuations in the prices of key commodities, including coffee, aluminum, sweeteners, plastics, and transportation costs. An increase in these costs can squeeze profit margins. For the second and third quarters of 2024, the company stated it had to take several actions related to pricing (due to inflation). A prolonged period of high inflation and high raw material prices can affect its margins.
  4. Technological Disruption: Technological innovations may render current K-Cup systems and brewing technologies obsolete. The development of more convenient or cheaper alternatives by a competitor can take away market share and profits.
  5. Regulatory Risks: Regulations concerning packaging, ingredients, trade agreements, and environmental matters can have an impact on KDP’s business, especially given the wide variety of geographies it operates in.
  6. Loss of a Major Customer: KDP depends on Wal-Mart for a significant part of its sales, and the loss of this client or significant sales decrease would impact performance.

Business Resilience: KDP has a strong portfolio of well-known brands and an important North American presence. It can rely on its distribution network and scale to have some resilience. However, it is important that they continue to improve upon their business and innovate to stay relevant in the long-term.

Financial Deep Dive

Here is an analysis of KDP’s finances:

Income Statement

  • Revenue: KDP reports its net sales by geographic segment. For the first nine months of 2024, U.S. Refreshment Beverages accounted for $5.1 billion, U.S. Coffee accounted for $3.4 billion and International accounted for $1.4 billion in net sales. We can see how strongly they rely on the U.S market.
  • Margins: The company has a reasonably high gross margin of 55.5% (First nine months of 2024) and an adjusted operating margin of 20.1% during the same time period. However, the profitability in the International segment is less than in the US segments, which causes a drag on the margin.

Margins are at risk of input prices going up and any changes in customer preferences, which might cause prices to come down. Management mentioned that although the company had a price increase it had to take more pricing action as its price elasticity is high. The company also admitted to seeing a slowdown in sales volume due to price increases and has been struggling to gain volumes. * Earnings: Diluted EPS of KDP for the first nine months of 2024 stood at $1.16 per share with a GAAP net income attributable to KDP of $1.6 billion, showcasing that the company is profitable.

Balance Sheet

  • Assets: As of September 30, 2024, KDP had total assets of $52.7 billion, which includes $632 million in cash and cash equivalents, $12.9 billion in goodwill and other intangibles, $10.5 billion in trade and other receivables. This means a lot of the company’s value comes from intangibles and goodwill, and they do not have a lot of liquid assets.
  • Liabilities: As of September 30, 2024, KDP’s total liabilities are $27.6 billion. This includes $12.9 billion in long-term debt, and $3.2 billion in short-term debt. While the liabilities are substantial, they are still well within what the company can handle as it has a history of debt and still maintains some profit and cash.

The company also had a $4 billion revolving credit agreement and $10 billion in long-term debt, which is an alarming amount of debt, but this is typical for such companies. There may be a bit of risk here. However, the company can take advantage of low rates.

  • Shareholders’ Equity: As of September 30, 2024, the total shareholders’ equity is $25 billion. The company has a total of 1,376,946,650 shares outstanding. The company also has a large value of shares repurchased by the company.

Cash Flow

  • Operating Cash Flow: In the first nine months of 2024, KDP has generated positive operating cash flow of $1.4 billion, highlighting its ability to generate profits from its core operations. The trend seems consistent over the past few years.
  • Free Cash Flow: Despite having positive operating cash flow, the company had a negative free cash flow due to large investments made by the company, including capital expenditures of $725 million and also $478 million in net investments.

In summary, KDP’s financial health is solid but with a high level of debt and low cash reserves, making it a medium risk company. If it can produce enough cash, the company might prove very worthy.

Understandability: 2/5

KDP’s business is somewhat complex due to its diverse set of brands and its different business lines (manufacturing, distribution, and coffee systems). While the basic concept of producing and selling beverages is straightforward, a detailed analysis of its operational metrics and finances is quite complex. The financial statements and especially the notes are also very complex and require a good understanding of accounting. For a typical investor, understanding the whole structure and model would take some time and effort, but it is certainly possible.

Balance Sheet Health: 3 / 5

While KDP has a strong portfolio of brands and decent operational numbers, it has also taken on some debt to expand its operations. The debt is manageable, given its strong business, but can become dangerous if it cannot generate enough profits and cash. Overall, the balance sheet health is reasonably good, but investors should closely monitor its debt levels, cash on hand, and its free cash flow.

Recent Concerns/Controversies and Management Outlook

  • Management has stated that the business environment remains unpredictable and volatile due to macroeconomic environment and the Ukraine-Russia war, which may impact its operations. It also stated that increased inflationary pressures will negatively affect its revenue and margins as its price elasticity is high.

  • Although management is confident it can control and manage its supply chain and costs, this is an important factor to watch. It’s not a sure bet that they can pass on all the prices to customers, particularly in the long term.

  • The company had a goodwill impairment of $154 million in the most recent quarter. Goodwill impairment charges point to the fact that a company overpaid for assets that had inflated values. Although non-cash in nature it can still represent bad management strategy in the past.

  • It seems that the company is shifting its strategic focus to its core business and also is shifting from volume based growth to value-based growth and increasing operating margins.

Summary

KDP is a moderate business with high brand recognition and established operations, and the company has a moderate moat, but it is also exposed to risks such as consumer preference changes, commodity costs, competition, and high debt. The company has been around for many years, and continues to make a respectable profit. The company’s value depends a lot on its ability to grow while keeping its costs stable.