Dr Pepper Snapple: Spin-off Bargain?

Dr Pepper Snapple

On Wednesday the 7th, Dr Pepper Snapple Group (::yahoo(“DPS”)::) officially began to trade. Its $25 price tag is lower than many expected after the soft-drink maker was spun-off of its parent company, Cadbury Schweppes.

Because spin-offs in general beat the market (and can make for excellent hunting grounds), I’m always looking for potential purchases. DPS stands out because of its well recognized brand names, competitive advantage, and unique spin-off situation.

Cadbury, its prior owner, trades on the London Stock Exchange. But when DPS was spun-off, it traded on the NYSE. This is a problem for mutual funds and institutions in the UK that owned Cadbury. They can’t or don’t want to hold a foreign-traded security. So more than likely (this may have already started), these institutions will sell their newly received DPS shares without regard to price.

Some of the brands of DPS include: Dr Pepper, Snapple, 7 UP, Motts, Sunkist, A&W, Hawaiian Punch. This post isn’t meant to be a complete analysis of the investment, just my initial thoughts on a potential opportunity.

Comparisons

The table below compares DPS with other soft-drink and consumer goods companies.

  Price Enterprise value 2007 EBIT EV/EBIT 3-year growth Return on tangible capital Operating margin
Dr Pepper $25 $10,162 $1,002 10.1 23% 54.4% 17.4%
Coca-Cola $56 $135,725 $7,252 18.7 11% 37.1% 25.1%
Pepsi $67 $108,721 $7,170 15.2 10% 41.7% 18.2%
Wrigleys $80 $22,561 $963 23.4 14% 49.5% 17.9%
Kraft $31 $67,686 $4,331 15.6 5% 28.8% 11.6%

As you can see from the above, DPS looks fairly cheap on a relative basis. Let’s compare Dr Pepper’s current price with the recent buyout of Wrigley’s by Mars and Warren Buffett:

Dr Pepper earns about the same pre-tax amount as Wrigley’s. Operating margins are approximately the same (17-18%), and Dr Pepper has a slightly higher ROIC. On a normalized basis, it looks like Dr Pepper’s margins may be around 19-20% of sales. In the last three years, Wrigley grew sales 14% annually versus Dr Pepper’s 23% (although DPS had declining margins).

So with the above comparisons, why did Buffett/Mars offer over twice as much for Wrigley’s? Was it international growth? Strength of the brand name? More potential for gum/candy than Carbonated Soft Drinks(CSD)?

Reflections on Coca-Cola

In 1988 and 1989, Warren Buffett loaded up on shares of Coca-Cola at a split-adjusted price of $5.48. At the time, Coke had a EV/EBIT multiple of about 9-10x. Ten years later (1998), Coke had reinvested about $7.4B, and increased pre-tax income by $3.4B. This comes out to a 45% return on incremental capital invested. An extremely high return over a ten-year period for a company of Coke’s size (thanks to the moat).

I don’t want to make too many comparisons between Coca-Cola and Dr Pepper Group. They sell similar products, and have valuable brand names, but very different economics. Coke has huge international presence, and a much larger share of the CSD market. Management at Dr Pepper have targeted for high-single-digit income growth. To me, little international presence seems like more of an opportunity than anything else…

Despite the differences, DPS may be a potential takeover target for a larger consumer goods company or even Mr. Buffett himself.

Stay tuned for further research…

Disclosure: We do not own any security mentioned in this post.

14 thoughts on “Dr Pepper Snapple: Spin-off Bargain?

  1. Thanks for reporting on this spinoff. I had forgotten about it.

    I had just one bit of feedback. I would avoid comparing the purchase price of Wrigley’s to that of Dr. Pepper. Buffett didn’t buy Wrigley’s. He only helped Mars finance the purchase. If he thought Wrigley’s was cheap enough, he would have bought the whole company himself.

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  2. George –
    Berkshire did provide the financing for the Wrigley’s deal, but I believe they will also get a small equity stake when the deal goes through.

    I agree that Buffett probably doesn’t see WWY as a huge bargain, but he must have believed it was at least somewhat undervalued to do the deal. I think (at current prices) a stock like WWY or Kraft fits into the “10% return” category he discussed at the meeting. The shareholder question was regarding the long-term returns Berkshire would get out of recent stock purchases, and Buffett said they would be happy with 10% returns going forward.

    I personally believe they’ll achieve higher returns than that, but it just shows you what Buffett’s expectations are. I would say a majority of future stock purchases by Berkshire (with a few exceptions) would fit into this category. And any small investor who knows what they’re doing could probably find better opportunities.
    ——–
    Here was my line of thought when making the WWY/DPS comparison:

    So IF buying Wrigley’s at $80 produced 10% returns over time (leaving synergies with Mars out of the equation), it could lead to this conclusion:

    WWY and DPS have about the same financial positions at the moment. So either (1) Dr Pepper shares will produce higher future returns than Wrigleys, or (2) Wrigley’s has much better future prospects and buying at 2x the price of DPS will lead to = or greater returns.

    Hope that made some sense.

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  3. I am watching this one closely. I really like the way it is being spun-off a UK-listed parent into a NYSE-listed equity. That has definitely been a contributing factor to the sell off during its first week and hopefully longer. I think also people are mentioning a lack of earning guidance and are waiting for the Q1 earnings guidance expected in early June. I would expect to see a price bounce around US$25 until then at the very least. Anything under $25 I would consider a buying point. Hopefully we will continue to see downward pressure for a few more weeks into lower $20s.

    My impression is that this is a nice opportunity for a bargain purchase because of an undervalued spin-off scenario. The company is moderately leveraged up with some sizeable new debt issued, has been gaining market share against big competitors in recent years, has many many valuable brands with moats up around them and established dominance, plus CEO Larry Young just bought 100 shares at $25 on last Friday May 9th (not many shares true but better than nothing!). I am loading up.

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  4. Well you know Coke and Pepsi have been selling off recently. So when they rally I would say the DPS would and then some.

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  5. I like this idea as i have been watching it as well.

    Sure on a comparative basis DPS is under valued to its peers but the peers have almost iconic brands and bigger market share.

    I would like to see it drop in the price before I get in.

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  6. George,

    First, the Mars family approached the Wrigley family.

    Second, Buffett bought $2B in equity and sold $4.5B in loans to Mars.

    Third, Buffett got a 20% discount on the $2B he bought… making over $400 mil on the transaction.

    – Vooch

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  7. Thanks for sharing the details on the amount of equity Buffett obtained in this deal. I thought he was only lending to Mars, I didn’t realize that he had bought $2 billion in equity.

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  8. Pingback: snapple 1988

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