sac team 3 dps 11.0

UT Dallas Student Research This report is published for educational purposes only by students

competing in the Security Analysis Competition

1

Highlight

Risks DPS currently faces: DPS currently keeps a high indebtedness of $2,541 million, which requires

a portion of the cash flow from operations to make interest payment, increasing its vulnerability even

with an efficient accrual ratio. As its goodwill and other intangible assets occupy 70% of total assets, an

incorrect estimation of these properties may result in an extra non-cash charge.

Solid business performance with sound financial position: Dr. Pepper Snapple displays high earning

quality measured by accrual ratio, showing more persistent and sustainable earning than reported. The

profit margin of DPS is stable and around the industry level. The company also has high efficient

operating management when its working capital is sufficient and cash conversion cycle has declined to

only 17.2 days. DPS's financial leverage supported by sustainable free cash flows and EBIT is

reasonable as well.

Revenue driver: Reducing calories and innovation to meet consumer’s preference, efficient

promotional and route-to-market strategies help DPS improved its market share of carbonated soft

drinks (CDS), which drive DPS’s revenue in the future. Besides, the increasing per capita real

disposable income and strong growth in Latin market are potential opportunities to expend its revenue.

Date: 11/11/2014 Ticker: DPS (NYSE) Recommendation: HOLD

Price: 69.95 Price Target: 71.96

Earnings/Share Mar. Jun. Sept. Dec. Year P/E Ratio

2011A 0.51 0.78 0.71 0.78 2.77 18.26

2012A 0.48 0.84 0.85 0.82 2.99 16.37

2013A 0.52 0.76 1.01 0.77 3.08 16.79

2014E 0.78 1.07 0.91 0.78 3.6 19.74

Recourse: Capital IQ, Yahoo Finance.

Market Profile

52 Week Price Range 46.88 –

70.35

Average Daily Volume 1,168,545

Beta 0.6

Dividend Yield (Estimated) 1.64(2.3%)

Shares Outstanding 194.4M

Market Capitalization 13.6B

Book Value per Share 41.82

Debt to Total Capital 32.9%

Return on Equity 27.4%

Recourse: Capital IQ, Yahoo Finance.

Beverages - Soft Drinks

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New entrants

in the …

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substitutes

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power of …

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Figure 1. Porter's Five Force Analysis

Adj Close, 70.47

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Figure 2. One-year DPS share price

Security Analysis Competition Date: Nov. 11th 2014

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Business description

DR Pepper Snapple Group, Inc. is a leading integrated brand owner, manufacturer and distributor of non-

alcoholic beverages in the United States ("U.S."), Canada and Mexico with a diverse portfolio of flavored

(non- cola) carbonated soft drinks ("CSDs") and non- carbonated beverages ("NCBs"), including ready- to-

drink teas, juices, juice drinks and mixers.

History: In the 1980's through the mid- 1990's, DPS began building on its then- existing Schweppes

business by adding brands such as Mott's, Canada Dry and A&W and a license for Sunkist soda. DPS also

acquired the Peñafiel business in Mexico. In 1995 and acquired Dr. Pepper/Seven Up, Inc. In 1999, DSP

acquired a 40% interest in Dr. Pepper/Seven Up Bottling Group, Inc. 2000, DPS acquired Snapple and

other brands, significantly increasing their share of the U.S. NCB market segment. In 2003, DPS created

Cadbury Schweppes Americas Beverages by integrating the way we managed our four North American

businesses (Mott's, Snapple, Dr. Pepper/Seven Up and Mexico). During 2006 and 2007, DPS acquired the

remaining 55% of DPSUBG, thereby expanding its geographic coverage. DPS were incorporated in

Delaware on October 24, 2007.

Products and Distribution: DPS’ portfolio includes more than 50 brands and hundreds of flavors of

carbonated soft drinks, juices, teas, mixers, waters and other beverages. DPS is a leading integrated brand

owner, manufacturer and distributor of nonalcoholic beverages in the U.S, Mexico and Canada, and they

also distribute its products in the Caribbean. In 2013, 88% of its net sales were generated in the U.S., 4% in

Canada and 8% in Mexico and the Caribbean. DPS sold 1.5 billion equivalent 288 fluid ounce cases in

2013.

Employees and Manufacturing: At December 31, 2013, DPS employed approximately 19,000

employees. In the U.S, it has approximately 16,000 full- time employees. In Mexico and the Caribbean, we

employ approximately 3,000 full- time employees. DPS do not have a significant number of employees in

Canada. As of December 31, 2013, DPS operated 20 manufacturing facilities across the U.S. and Mexico.

Almost all of our CSD beverage concentrates are manufactured at a single plant in St. Louis, Missouri.

DPS employed approximately 5,000 full- time manufacturing employees in its facilities at December 31,

2013. In 2013, 90% of our manufactured volumes came from our brands and 10% from third party and

private- label products. We also use third party manufacturers to package our products for us on a limited

basis.

Business: DPS do three parts of business, beverage Concentrates segment, package beverage segment, and

Latin America Beverages segment. For beverage concentrate segment DPS had net sales of approximately

$1,229 million in 2013, PepsiCo and Coca-Cola are the two largest customers of the Beverage

Concentrates segment, and constituted approximately 26% and 21%, respectively, of the segment's net

sales during 2013. For package beverage segment, DPS had net sales of approximately $4,306 million in

2013. Approximately 84% of its net sales come from its own brands, and DPS also do the route-to-market

for third party brand owners to exposure in certain markets with low investment. For Latin America

Beverages segment, DPS had net sales of $462 million, with its operations in Mexico representing

approximately 90% of the net sales of this segment.

Business strategy:

For brands, DPS intends to build and enhance leading brands, and identifies key brands that they believe

have the greatest potential for profitable sales growth. DPS invests most heavily in its key brands to drive

profitable and sustainable growth by strengthening consumer awareness. Solutions include new and

reformulated products, improved packaging design, pricing, and enhanced availability. We use advertising,

sponsorships, merchandising, public relations, promotions and social media to provide maximum impact

for our brands and messages.

For distribution, DPS focus on new distribution agreements for new, high-growth thirds party brands to

create a win-win situation. In additional, DPS continued the placement program for its branded coolers and

other cold drink equipment. Also DPS increases presence in high margin channels and packages.

For operation, DPS created multi- product manufacturing facilities, which provide a region with a wide

variety of our products at reduced transportation and co-packing costs. DPS also intend to improve

operating efficiency. In 2011, DPS launched Rapid Continuous Improvement ("RCI") initiative, which

uses Lean and Six Sigma methods to deliver customer value and improve productivity, achieving net

income growth and increasing the amount of cash returned to stockholders.

88%

8%

4%

Fgure 3: global market share

US market Mexico Canada

Source: company data

2010

2011

2012

2013

others 588 612 635 651

coca-cola 252 240 220 258

pepsi 360 348 366 320

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Figure 4: Concentrates distribution

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Figure 5: slaes distribution (Dec31,2013)

Beverage Concentrates

Package beverage

Latin America Beverages




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Investment Summary

External Sale Drivers

Per capita carbonated soft drinks consumption: As per capita carbonated soft drinks consumption

declines, demand from downstream markets, such as Wal-Mart and Target, will decline and negatively

impact DPS revenue. The per capita CSD consumption in U.S. is decreased from 172.5 liters in 2009 to

159.7 liters in 2013. As the public concerns about health, we believe the data would continue to decrease

in the future.

Per capita real disposable income: The liquid refreshment beverages are affordable for consumers,

however, if the disposable income declines, consumers would turn to more affordable options, such as

bottled and tap water, which is not strong revenue driver for DPS. Per capita disposable income was

increase from $35,617 in 2009 to $37,670 in third quarter 2014. Due to the strong economic foundation in

U.S. Per capita disposable income is anticipated to rise in the future.

Internal Sale Drivers

Strong growth in Latin America: Volumes sales in Latin America increased 10% in third quarter 2014,

compared with the year ago period. And sale for Latin America Beverages increased 19% relative to the

results posted in the third quarter of 2013, and increase 16.8% in first three quarter compared to last year

period. As Coca-Cola volume growth rate is only 2% in Latin America area. This might indicate that Dr.

Pepper has ability to compete with its rivals and to improve its market share in Latin America area.

Efficient promotional strategies: DPS builds its brands not only by introducing new flavors and

innovation but by executing promotional strategies. For example, In DPS advertising, DPS not only

emphasizes unique of its brand but also unique people who are tired of dealing with the “cola wars” and

just want something new that will quench their thirst. The company invested in platforms in digital media,

such as Facebook, to market Snapple in 2013. Besides it held many promotional activities, such as ”Be the

Next/1’’, a national consumer contest, “Live it Up with Enrique” and Tuition Giveaway during 2013 and

2014. These efforts paid off and helped Dr Pepper improve its market share in U.S. According to

Beverage-Digest, Dr Pepper Snapple Group CSDs’ market share grows for 8th consecutive years from 14.6%

in 2005 to 16.9% in 2013 and correspondingly it total sale increases from 3,065 million to 5,997 million.

Efficient route-to-market strategy: DPS has efficient route-to-market strategy by creating a consolidated

bottling system to manufacture and distribute its own brands, such as 7UP, Sunkist soda, A&W, Peñafiel

and Snapple. It’s very important for DPS, because DPS not only could deliver most of its non-popular

brands to the target market to increase market share by its own force but also saves much money by using

third bottling company to sell its popular brand (Dr Pepper) to the market they could not reach. This

strategy could significantly impact its market share in U.S. The result from this strategy is successful. 7UP,

A&W, Canada Dry and Sunkist soda (4 core brands) increased 3% compared to the year ago period,

Peñafiel grew 25%, and Snapple and other brands’ volume are flat. Even though the biggest brand, Dr.

Pepper, declines 2% volume in year 2014, Major brand, Diet Coke, for Coca-Cola declines 7% volume in

North America in same period. Besides, Dr. Pepper completed its acquisition of the business assets of

Davis Beverage Group and Davis Bottling Co. The acquisition allows Dr. Pepper to reach 42-county

territory, covering most of the Eastern half of Pennsylvania as well as Western and Central New Jersey.

Focus on reducing calories and innovation to meet consumers’ preference: Because of increasing

concerns in healthy lifestyle in U.S., DPS continue to provide a full range of products, with at least 50

percent of innovation projects in the pipeline focused on reducing calories, offering smaller sizes and

improving nutrition.

Specialized flavored CSD: Specialized flavored CSD contributes to building DPS’s moat (distinctive

non-cola business), which make DPS avoid to directly compete with likes of Coke and Pepsi in cola business.

DPS decreased its market share of flavored CSDs from 40% to 39.5% for past 3 years as measured by retail

sales according to Nielsen due to competition with other non-cola products such as Pibb xtra. And we believe

DPS could maintain the market share from a range of 38.5% to 39.3% during the next 5 years.

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Figure.6 Consumption per capita in US

DPS Rev

CSD Consumption per capita in USA

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Figure.7 per capitareal disposable incoem

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Figure.8 CSD Mkt Share- DPS

CSD Mkt Share-DPS DPS Rev

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Figure.9 LRB Mkt share-DPS

LRB Mkt share-DPS DPS Rev


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Revenue growth forecast Even though per capita carbonated soft drinks consumption in the U.S. is expected to decline due to health

concerns as well as flavored CSDs market share is expected to decline, DPS proved that it has abilities to

expend overall CSD market share to drive revenue through efficient promotional strategies, efficient route-

to-market strategy and reducing calories and innovation to meet consumer’s preference. Besides, the

increasing per capita real disposable income and strong growth in Latin market shows a good side for

DPS’s revenue growth in the future. So we forecast that DPS would increase its CSD market share in U.S

to 18% in year 2018. And we also found that CSD market share could statistically significantly explain

DPS’s total revenue growth based on the total revenue per 1% CSD market share for past 3 years, which

are stable as 353.5, 356.8 and 354.9, we estimate revenue growth rates are 1%, 2%, 1.7%, 1.1% and 0.6%

in the next 5 years. (1% growth rate in year 2014 is based on 2014 full-year guidance in Q3 2014 result.)

(Refer to Appendix 1 Key Statistics of Driver Analysis)

Industry Overview and Competitive Positioning

Company Strength

Operational Efficiency: DPS reported strong operational efficiency with decreasing cost and increasing

margins in 2014. The operating margin increased 432, 365 and 45 basis points in latest three quarters in

2014 over latest three quarter in 2013, which contributes to lower packaging, ingredient costs and efficient

cost management (Rapid Continuous Improvement Program) or a strong pricing strategy by the company.

Even if we ignore the effect of packaging and ingredient cost fluctuation, the ratio of SG&A to sale

decreased by 117, 213 and -28 basis points from first three quarter in 2013, which indicates a significant

cost management control. On the other hand, the ratio of OCF to sale for latest three quarters in 2014 also

increase 365, 541 and 11 basis points compared to in 2013. (Refer to Appendix 3 Significant Margins in

DPS’ Operating Process)

Diverse portfolio of products: DPS has well- known CSD and NCB brands, which include soda, juice, tea

and bottled water. Many of our brands enjoy high levels of consumer awareness, preference and loyalty

rooted in their rich heritage, which drive their market positions. Some of CSD brands offer 7UP, Dr Pepper

(brand), A&W, Sunkist soda, Canada Dry, Squirt, RC Cola, Big Red, Vernors and Diet Rite. Some of NCB

brands have Snapple, Hawaiian Punch, Mott's, Clamato, Yoo-Hoo, Deja Blue, FIJI, AriZona, ReaLemon,

Nantucket Nectars, Mr and Mrs T mixers, Mistic and Rose's.

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Q1 2014 Q2 2014 Q3 2014

Figure.11 Operational Data fluctuation

COGS as a % of sale change

SG&A as a % of sale change

OCF as a % of sale change

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Figure.10 Dr Pepper share prices and news flow

DP

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DPS Announces $715M Distriution

Investors Snap into DPS Following Strong

Moody's upgrades DPS to

DPS Loses Cadbury Schweppes Age

DPS Tops Q3 EPS by 10c, Raises FY EPS Guidance

DPS misses expectations

Soda Makers DPS, along with KO and PEP, Join in Effort to Cut Americans’ Drink Calories

DPS reture to profit in quarter, year


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Flavored CSD Brand: DPS’s products are biased toward flavored CSDs, which continue to gain market

share versus cola CSDs. DPS dominates the Non-Cola business, which is the #1 flavored CSD company in

the U.S. It has 39.5% retail market share in non-cola business. Its largest brand, Dr Pepper, is the #2 overall

flavored CSD in the U.S., according to Nielsen. Overall, in 2013, approximately 83% of its volume was

generated by brands that hold either the #1 or #2 position in their category.

Integrated business model: DPS operates as an integrated brand owner, manufacturer and distributor

through our three segments. The integrated business model strengthens its route- to- market and provides

opportunities for net sales and profit growth through the alignment of the economic interests of its brand

ownership and its manufacturing and distribution businesses through both its Direct Store Delivery ("DSD")

system and its Warehouse Direct ("WD") delivery system. The integrated business model enables the

company to be more flexible and responsive to the changing needs of its large retail customers and allows

it to more fully leverage its scale and reduce costs by creating greater geographic manufacturing and

distribution coverage.

Threat

Higher operating leverage: During a business decline, the operating earnings will decline by a larger

percentage than sales, because of much higher operating leverage than that of competitors, such as KO and

PEP.

Trademark and formula right: The Competitors, such as Coca-Cola, own the Dr Pepper trademark and

formula in certain other countries, which might negatively affect international expansion for DPS

Opportunity

Limited international presence: DPS derives 88% of its net sales from the U. S. By contrast, Coca-Cola

and PepsiCo derive only 40% and 51% of their net sales from the U. S., according to Morningstar. There is

great potential opportunity for DPS to expend business internationally.

Non-carbonated beverages (NCB): With the health concerns surrounding carbonated soda beverages, it's

essential that DPS expands NCB brands, which only comprise 20% of DPS's revenue in 2013. The

company already owns juice brands, such as Hawaiian Punch, bottled water brands, such as Peñafiel and

Tea brands, such as Snapple. And according to the Marketline, the juices, Bottled water, and RTD tea &

coffee segments account for 20.5%, 13.8% and 8.4% of soft drinks market’s total value. This is still a big

market for DPS.

Sport & energy drinks: The sport & energy drinks are experiencing high growth in soft drink market.

Their sale is increased 3.57% in 2013 to 17.4 billion in North America, the fourth straight year of increase

and the highest since 2014. DPS already own the energy drink brand, such as Venom Energy. There is a

potential opportunity to grow DPS’s revenue.

Weakness

Reliance on competitors’ bottling system: DPS relies too much on competitor’s bottle systems. 63% of

Dr. Pepper (brand name) volumes are distributed through the Coca- Cola affiliated and PepsiCo affiliated

bottler systems in 2013. This might limit DPS to extend its market share.

Limited profit sources: DPS lack of international exposure, which might limit DPS ability to mitigate the

effects of a declining U.S. market due to health concerns by expansion of its sales abroad in high growth

regions, such as Asia.

Porter’s Five Forces Analysis

Threat of new entrants in the industry – High: The US soft drinks market is characterized by the

presence of large players, such as Coca-Cola and PepsiCo, which benefit from high scale economies.

Several well-known brands’ recognition already built up. The capital expenditure in early stage is still

intensive, in particular for manufacturing and distribution. New entrants might be subject to some federal,

state and local laws and regulations in some place.

Threat of substitutes – Medium to High: Soft drinks are affordable for almost everyone, it’s easy to

switch brands if one desires. So it’s crucial for soft drink firms to please their customers. If customer

satisfaction weakens, consumers become more reluctant to buy and brand loyalty suffers. This will cause

firms typically respond by offering deals and price discounts due to demand declined, which might

contribute to more volatile revenue, operating income streams and lower margins. According to the ACSI,

customer satisfaction scores (CSS) of Dr. Pepper Snapple from 2012 to 2014 are 87, 86 and 82. And

average CSS of DPS from 2006 to 2014 is 85.2, which is higher than 83.89(Coca-Cola), 84.56(PepsiCo)

and 83.89(industry). Besides, the coefficient of variations of sale and operating income are 3.71% and 3.59%

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Figure.12Customer Satisfaction Scores

Coca-ColaPepsiCoSoft Drinks


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for past 5 years, compared to 18.96% and 12.70% for Coca-Cola and 16.68% and 8.82% for PepsiCo. And

the gross margin of DPS is stable as 58% for pass 3 years. These might indicate buyer propensity to

substitute is comparable low for DPS. (Refer to Appendix 2 Customer Satisfaction Scores)

Bargaining power of buyers – Low to Medium: PepsiCo and Coca- Cola are the two largest customers

of the Beverage Concentrates segment, and constituted approximately 26% and 21%, respectively, of the

segment's net sales in 2013. However, DPS has 20-year contractual obligation with both companies so that

it’s hard for them to change it. Food and beverage retailers, such as Walmart, which is the largest customer

of its Packaged Beverages segment, accounted for approximately 16% of our net sales in this segment in

2013. These large buyers might have high bargaining power. On the other hand, DPS already dominated

the flavor CSDs market and built its brand loyalty, which might mitigate the bargaining power of buyers.

Bargaining power of suppliers – High: The company has contracts with a relatively small number of

suppliers (15), compared to 81 suppliers for Coca-Cola and 66 suppliers for PepsiCo. The top 5 of

suppliers for Dr. Pepper account for 79.33% of cost incurred by total suppliers, in contrast to only 36.76%

for Coca-Cola and 34.15% for PepsiCo according to Bloomberg. Besides, in contrast to the relationship

value with same suppliers, such as Crown Holdings Inc., for Coco-Cola and PepsiCo, the relationship value

is relatively lower for DPS according to the Bloomberg, which might strengthen the power of suppliers. On

the other hand, raw materials, such as sweeteners, have substitutes available based on Market line report.

Rivalry among existing competitors – very high: The Liquid Refreshment Beverage (LRB) industry is

highly competitive and continues to evolve in response to changing consumer preferences. Competition is

generally based upon brand recognition, taste, quality, price, availability, selection and convenience. DPS

competes with multinational corporations, such as Coca- Cola and PepsiCo, with high scale economics and

significant financial resources, which allows them to engage in price competition. They collectively

represent approximately 60% of the U.S. LRB market by volume, according to Beverage Digest. Dr.

Pepper need to compete with its competitors for every soft drinks segments, such as carbonates, juices,

energy drinks, bottled water and RTD tea, and DPS does not rank in 8 top for every segments except for

carbonates.

VALUATION

We have considered three approaches to value DPS, discount free cash flow (DCF) model, comparable

company multiple pricing, and residual income model.

DCF valuation

In applying the DCF approach, we used three years historical data and five year forecast data of income

statement, cash flow statement, and balance sheet. We also built depreciation schedule, debt schedule, and

operating working capital sheet, all numbers are linked in these spreadsheet. Our valuation is based on the

two- stage growth model. In the first stage, we assumed DPS has a relatively high growth period for from

2014 to 2018, and in the second stage, DPS has a perpetually low constant growth rate. In November 11

2014, which from $65.32 to $71.96.It is sensitive mostly to the following factors:

Revenue: The forecast of growth in sales is based on industry analysis and company operational analysis,

and market influence analysis. We focus on the historical data of DPS as well as the data of market. Our

estimated revenue growth rates are 1%, 2%, 1.7%, 1.1% and 0.6%.

Cost of goods sold: Company controlled cost more efficiently this year. Packaging and ingredient costs,

including LIFO impacts, are now expected to decrease COGS by 2.5% to a constant volume/mix basis,

leading COGS as a percentage of revenue declined from 41.7% to 40.2 %. (From Dr. Pepper Snapple

Group Reports Third Quarter 2014 Results). However, we think that COGS as a percentage of revenue

could not be sustainable for the future because of fluctuation of ingredient price. High fructose corn syrup

is a key ingredient used to produce regular soda. A rise in the price of corn would significantly affect the

profitability of DPS. The price of corn is expected to increase in 2015, because the corn oversupply in early

2014 already made the price at low level for a long time, and the Department of Agriculture lowered its

crop estimate by 0.5% and estimated stockpiles at the end of the season will be 3.5% smaller than predicted

in Oct 2014. This might presents a potential threat for the industry.

Cost of debt: We calculate the cost of debt of DPS with fair value of long-term debt (Senior Unsecured

Notes). According to the NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS, we

used fair value and market yield of long-term debt (from Morningstar) to calculate the weighted average of

market yield, and got the 2.33% as cost of debt. Because the amount of short-term debt of DPS is extreme

low compares to the long-term debt, we ignore the effect of short-term debt.

Cost of Debt

Pay down

year

Fair

value

Market

yield

2016 514.0 0.71%

2018 843.0 2.01%

2019 254.0 2.28%

2020 243.0 2.38%

2021 254.0 2.98%

2022 240.0 3.19%

2038 352.0 4.39%

2.33%

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existing …

Figure 13. Porter's Five Force Analysis


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Cost of equity: We use CAPM model to calculate the cost of equity, we use 30-years US Treasury Rate on

November 7, 2014 as risk free rate, which is 3.04%, market risk premium is 5.4% (based on A.

Damodaran’s estimation). The after-tax cost of debt was calculated using weighted average market yield,

at the same time fair value of debt was calculated in WACC (from Morningstar).

Beta: Using past 5 years DPS daily return rate and S&P 500 daily return rate, we do the auto-regression to

calculate the beta of DPS. We found the historical beta tend to move to a certain number and got the Mean

Reverting Line, which represents the beta should be 0.6.

Effective tax rate: Company has a negative tax number in 2013, as completed by IRS audit. When

excluding tax and indemnity, effective rate should be 35.5%, similar as 2012 and 2011.

Debt schedule: We assumed that long term debts and short-term borrowings will stay the current level,

which around 2500 million. In addition, company has enough cash flow to cover interest payment or pay

down the debt each year.

Depreciation schedule: We used Gross PP&E/Depreciation expense in 2013 to get CAPEX useful life of

13 years, and net PP&E/Depreciation expense in 2013 to get PP&E useful life of 6 years. CAPEX

increased at the same rate of sales.

Operating working capital: We used last two years data and historical trends to calculate accounts

receivable days, inventory turnover days, prepaid expenses days, accounts payable days, deferred revenue

payable days and accrued taxes payable days.

Operating lease: Moody's Aaa rates through December 6, 2001, are averages of Aaa utility and Aaa

industrial bond rates. Because operating lease is secured by the underlying asset, it's less risky than the

company's unsecured debt

Terminal value: We use two methods to calculate the terminal value, EBITDA method and perpetuity

method. With EBITDA method, we estimate Exit Year EBITDA and calculate EBITDA multiple (10.5x).

With perpetuity method, we assumed a low 0.5% perpetuity growth rate because of the risk of a minimum

wage increase, interest rate increase, and US market saturation.

Comparable companies’ analysis

While the DCF method was the main valuation approach, we also chose appropriate peer group. We

conducted multipliers pricing using benchmark EV/Revenue, EV/EBITDA, EV/EBIT, and P/E, all based

last twelve months. As mentioned in industry overview, Coca-Cola Company, Pepsi are two leading

companies in the industry, with market capitalization of 179,409.4 and 141,713.6 million respectively. We

also chose some relatively smaller companies such as Cott Corporation and Monster, which has similar

total equity value as Dr. Pepper.

In EV/Revenue multiple method, Dr. Pepper has 2.5x between peer group mean and median, but it has

higher financial leverage than comparable companies, and we got lowest price range with this multiple. For

EBITDA multiple, Dr. Pepper is little lower than industry average number, and we calculated price range

by using this multiple most nearly to DCF analysis. With EBIT multiple, Dr. Pepper is extremely lower

than average level, because DPS has high operating leverage, generating large deprecation expense. When

we used this multiple, we got higher price range than EBITDA.P/E ratio of DPS is also lower than mean

and median, for the reason DPS repurchased stocks of 400 millions, which make EPS increased rapidly,

consisting one of reason for very high price range by this multiple.

All major multiples of DPS are less than peers’ median, which is actually mean number of Coca-Cola and

Pepsi. As conclusion, majorly based on EBITDA multiple, we used the mean number of four multiple

median price and got price of 75.15.

Cost of Capital

Risk Free Rate 3.04%

Market Risk Premium 5.43%

Beta 0.6

Cost of Equity 6.30%

Cost of Debt 2.33%

WACC 5.56%

-1

-0.5

0

0.5

1

1.5

2

Mean Reverting Line

0.6

50.65

74.09

93.78

82.08 72.53

83.22

96.98 94.32

40.00

50.00

60.00

70.00

80.00

90.00

100.00

110.00

Fiture. 15 Comparable Estimate

Figure.14 Beta Fluctuation


8

Financial analysis

Sustainable Earnings with High earning quality

Both Positive and increased top-line and bottom line: According to Dr. Pepper Snapple’s 2014 Oct Form

10-Q, the company reported USD 6075 million total revenue with growth of 1.3%, and USD 709 million

net earnings with growth of 13.6% for the latest annual period.

Upward trend of gross margin with low level of working capital tied up: Gross margin is improved

from 58.3% to 59.5%. For the last annual period, the company's gross profit improved $117 with a positive

change of 128 in working capital, which is still in low level compared to historical working capital tied up

with same gross profit improved; it is quite possible that the company’s performance is a result of truly

delivering in the marketplace and not simply a prop up using the balance sheet.

Negative accruals and accrual ratio: Based on the number of its accruals ( 2014 Sep USD-143 million)

and accrual ratio (2014 Sep -1.5%) (Refer to the appendix.13 Accrual ratio of DPS and its competitors), it

suggests that the company’s earning quality is improving with enough persistent and sustainable earnings.

Because free cash flow becomes greater than net income, cash earnings are higher than accrual earnings.

Compared with the peer group, the company’s earning quality is above the average level. The gross margin

of DPS is very stable for the past three years, and is a little above the average level. While it’s net income

margin, which is around 10.5%, is lower to the average level. There are both uptrend in the both of gross

margin and profit margin.

Over performed bottom-line compared with top-line: By looking at revenue growth and earnings growth,

we can understand a company’s ability to grow its market share and the ability to generate returns. Dr.

Pepper Snapple’s year-on-year change in top line of 0.9% is worse than its change in earnings which is 11%,

suggesting perhaps that its focus is on the bottom-line to generate profits rather than gaining market share.

Greater operating cash flow growth versus earnings growth: DPS’s year-on-year change in operating

cash flow of 17.7% is better than change in earnings of 13.6%, suggesting that the company might have

been able to declare a higher earnings number. In addition, this change in operating cash flow is better than

average among the declared results thus far in its peer group.

Strong driver of profitability to support growing ROE under DuPont Analysis

Fluctuated equity multiplier: For the past three years, DPS’s equity multiplier fluctuated around 4.0.

Based our forecast for the next five year, the equity multiplier may decreased to about 3.3 due to the high

risk of high financial leverage. (Refer to the appendix. 16 DuPont Analysis)

Sustainable profit margin and increasing asset turnover: In the analyzed historical period, DPS

exhibited high return on equity, which surges from 25.7% in 2011 to 27.4% in 2013. The main drivers of

the improved ROE come from the increase in asset turnover (2013 0.7X) comprise the little drawback in

profit margin and equity multiplier. We forecast ROE for the next four year is around 28% due to the stable

increased profit margin, and high improved asset turnover comprised by decreasing financial leverage.

3%

7%

14%

12%

0% 33%

29%

1%

0% 1%

Figure.17 Asset Base Composition

Total Cash & ST Investments

Total Receivables

Total Current Assets

Net Property, Plant & Equipment

Long-term Investments

Goodwill

Other Intangibles

Deferred Tax Assets, LT

Deferred Charges, LT

Other Long-Term Assets

25.7%

27.7% 27.4%

28.7%

29.3%

26.8%

28.0% 27.5%

23%

24%

25%

26%

27%

28%

29%

30%

20

11

20

12

20

13

20

14

E

20

15

E

20

16

E

20

17

E

20

18

E

Figure. 16 ROE


9

High intangibles proportion in Asset Base

Over half intangible assets: Up to 2104 Sep, 68.7% of Dr. Pepper’s assets were represented by goodwill

and other intangibles, such as brands, probably due to the acquisition and indefinite use life of its brands.

There is high risk for DPS to suffer a great deduction in total assets due to any significant impaired value in

intangibles. (Refer to the appendix. 16 DuPont Analysis)

Other assets base composition: 14.3% accounted for net PP&E, 7.6% for receivables and 3.4% for cash &

ST investment. The proportion of cash in total assets suffered a significant decrease from 7.6% in 2011 to

1.9% in 2013, while its receivables remain constant at around 6.5%. The large decrease from 366 million to

153 million in 2013 is due to the repayment of USD 250 million debt payments. Despite of the jump in cash,

the current ratio and the quick ratio of DPS is stable, around at 1.1x and 0.8x separately which is very close

to its peer. Fixed asset turnover of DPS is about 5.1x compared to the peer level of 3.5x, showing a more

efficient usage of equipment. DPS is also enjoys a higher level of inventory turnover (2013 12.6x) than its

peer.

Above average financial risk but in reasonable level because of lower business risk

Stable capital structure: DPS’s capitalization consists of about 52% of debt and 48% of equity. This

proportion is somewhat consistent over last three years.

Close to peer group level financial leverage: The financial leverage measured by debt-to-equity ratio

decreased from 1.23 to 1.08 from 2012 to 2014-Sep. DPS has a reasonable financial leverage considering its

interest coverage ratio (2014-Sep 11.4x). Apart from that, Monster, its competitor and comparable, has no

debt at all. And Coca-Cola and PepsiCo have much bigger market capitalization as well as high interest

coverage ratio.

Lower business risk: DPS exhibits a lower business risk due to the small coefficient of variation (CV) of

the firm’s sale and operating income for past five years. (3.71% & 3.59%) compared to its peer group. (PEP:

16.68% & 8.82%; KO: 18.96% & 12.70%)

Mainly focus on packaged beverages segment and U.S market

Corresponding segment contribution with capital allocation: Dr. Pepper Snapple’s revenue comes from

three segments. By looking into the assets allocation, it is pretty close to the proportion of the contribution

of three segments. Apart from the 86.6% of corporate and other assets, among total assets for those three

segments, beverage concentrates which account for 20% is supported by 7% assets, packaged beverages

accounted for 72% revenue supported by 85% of assets, and Latin America beverages of 8% of revenue

with 8.4% of assets. What’s more, based on the historical data in the past three year, the revenue from those

three segments is pretty stable, no big change. We expected this trend could be continued for the next 5

years.

Focus on United States market: Nearly 90% annual revenue is contributed by the United States market,

when international market is only a small portion. And there is no expected big breakthrough plan

announced by the company in increasing international market share. Due to the stable market share in

domestic market, it’s likely that no significant surge in the total revenues.

Investment Risks

These factors below could lead the stock price out of our range of target price:

Economic Risk | National or global recession (ER1): Changes in economic and financial conditions,

especially in the U.S., Canada, Mexico or the Caribbean, may negatively impact consumer confidence and

spending, enterprise financing and commercial relationships. Counterparty risk for cash investments and

hedging arrangements would also increase. Declines in the securities and credit markets could also affect

the marketable securities and pension fund, which in turn could increase funding requirements.

Economic Risk | Highly Competitive Market (ER2): Dr. Pepper competes with multinational

corporations with significant financial resources. The two largest competitors are Coca-Cola and PepsiCo,

while competition against other large companies also exists. These competitors can use their resources and

scale to rapidly respond to competitive pressures and changes in consumer preferences by introducing new

products, changing their route to market, reducing prices or increasing promotional activities. As a bottler

and manufacturer, Pr. Pepper also compete with a number of smaller bottlers and distributors and a variety

of smaller, regional and private label manufacturers. In Canada, Mexico and the Caribbean, they compete

with many of these same international companies as well as a number of regional competitors. A failure in

any competition will result in lower price or higher expenditure; therefore negatively affect its business and

financial performance.

-2.0%0.0%2.0%4.0%6.0%8.0%

10.0%12.0%14.0%16.0%18.0%20.0%22.0%

Figure. 18 Accrual Ratio

Dr Pepper Snapple

Coca-Cola

Pepsico

Figure. 19 Risk Summaries


10

Political Risk | Changes in accounting regulations and tax-related policies (PR1): Changes deliberated

by Financial Accounting Standards Board to existing standards could have a material impact on certain

accounting subjects in the consolidated financial statements. During the fourth quarter of 2013, the

government of Mexico enacted broad based tax reform, including a one peso per liter tax on the

manufacturing of certain sugar health care costs associated with obesity. On November 5, 2014, Berkeley

has approved the nation’s first soda tax and San Francisco is also planning to do so, which is to slap a tax of

two cents an ounce on nonalcoholic drinks with caloric sweeteners. Federal, state, local and other foreign

governments could also impose taxes on sugar as a result of these concerns. Any changes of regulations or

imposed taxes may reduce consumer demand for our products or could cause us to raise our prices, both of

which could have a material adverse effect on our profitability and negatively affect our business and

financial performance.

Political Risk | Failure to meet food security standard (PR2): A failure to meet various quality,

environmental, health and safety standards could also occur in the operations or those of the bottlers,

distributors or suppliers. Scandals will have an obviously negative impact on their reputation and hence

revenue.

Market Risk | Preferences of consumers (MR1): Consumers' preferences can change due to a variety of

factors. Developing and launching new products can be risky and expensive. They may fail in responding to

changing markets and consumer preferences, while some of the competitors may be better able to respond

to these changes. Unusually cool weather during the summer months may also result in reduced demand for

the products and have a negative effect on the business and financial performance.

Market Risk | Prospective international market (MR2): While Dr. Pepper Snapple Group is planning to

further expand its international markets, they would face more complicated consumer preferences and deal

with new regulations. Failure on any of these markets would partly affect the performance of Dr. Pepper.

Operational Risk | High proportion of indebtedness (OR1): As of September 30, 2014, the total

indebtedness was $2,541 million which could require a portion of the cash flow from operations to make

interest payments on this debt and increase the vulnerability to general adverse economic and industry

conditions, which could impact the debt maturity profile.

Operational Risk | Substantially raising producing cost (OR2): The cost of the principal raw materials

they use in the products such as containers, fruit, water and other ingredients can fluctuate substantially. In

addition, there are significantly impacted by increases in fuel costs due to the large truck fleet they operate

in the distribution businesses and the use of third party carriers. Continued energy price increases could

exert pressure on the costs and the company may not be able to effectively hedge or pass along any such

increases to the customers or consumers. Unseasonable or unusual weather or long- term climate changes

may also negatively impact the price or availability of raw materials, energy and fuel. Costs for benefits

such as employee health care and pensions will increase based on recent trend. Substantial disruption to

production at the manufacturing and distribution facilities could occur. The facilities and operations may

require substantial investment and upgrading. Water availability risks would also be a trouble. Additionally,

Dr. Pepper is currently participating in multi-employer pension plans in the United States, expiring at

various dates through 2016. A withdrawal charge of $56 million would occur as they intend to withdraw

from any of these plans.

Operational Risk | High dependency on main competitors (OR3): Dr. Pepper depends on third party

bottling and distribution companies for a portion of their business, hence they are subject to a risk of the

allied brands terminating their distribution agreements. Since only a small number of suppliers and retailer

are availale, shortages could occur. They also rely on third party providers for a number of key information

systems and business processing services, which are vulnerable to interruptions or other failures. Especially,

a large proportion of Dr. Pepper’s operation processes relies on main competitors. In the last fiscal year,

Coca-Cola contributed 26% of Dr. Pepper’s revenue while PepsiCo contributed 21% to Dr. Pepper’s

Beverage Concentrates segment. On the other hand, 63% of Dr. Pepper’s volume is distributed through the

bottlers of Coca-Cola or PepsiCo. Since they also compete with each other, there could be a potential risk

that Coca-Cola or PepsiCo (or both of them) choose to end their contracts.

Operational Risk | Estimation of intangible assets value (OR4): The indefinite value of the goodwill and

other intangible assets could have a material adverse effect on the results of operations. Dr. Pepper is

reported to have approximately $5,687 million goodwill and other intangible assets. If the carrying amount

of an intangible asset exceeds its fair value, an impairment loss will be recognized in an amount equal to

that excess. Impairment could be recorded as a result of changes in assumptions, estimates or circumstances,

some of which are beyond the control. Any such unpredictable impairment would result in us recognizing a

non-cash charge in the Consolidated Statements of Income. Litigation or legal proceedings could expose Dr.

Pepper to significant liabilities and damage the reputation including an infringement of intellectual property.

Risks Mitigating Factors

Economic Risks

National or global

recession

Adjustments to the

valuation assumptions

as the economic

changes

Highly competitive

markets

Development of unique

products; Advertising

Political Risks

Changes in accounting

regulations and tax-

related policies

Maintain a sufficient

sale to deal with the

alters

Failure to meet food

security standard

Refine the

manufacturing and

testing processes

Market Risks

Preferences of

consumers

Diversification of

products

Prospective

international market

Low initial investment

in new markets to

maintain a low risk

before being mature

Operational Risks

High proportion of

indebtedness

Keeping a sufficient

cash flow to pay the

debt

Substantially raising

producing costs

Seeking for more

supplier and reasonable

futures contracts

High dependency on

main competitors

New acquisition of

bottlers

Estimation of

intangible assets value Lower the leverage


11

Appendices

Appendix 1 Key Statistics of Driver Analysis

2006 2007 2008 2009 2010 2011 2012 2013

DPS revenue (Million dollars) 4700 5695 5710 5531 5636 5903 5995 5997

CSD Market Share-DPS 14.89% 15.03% 15.29% 16.37% 16.69% 16.70% 16.80% 16.90%

LRB Market share-DPS - - - - 11.30% 11.30% 11.30% 11.30%

CSD Consumption per capital in USA (Liter) - - - 172.5 170.8 167.9 163.9 159.7

Per capita real disposable income (Dollar) - - - 35617 35687 36315 37115 36815

2014E 2015E 2016E 2017E 2018E

DPS revenue (Million dollars) 6056.97 6177.99 6284.51 6355.52 6391.02

CSD Market Share-DPS 17.10% 17.40% 17.70% 17.90% 18.00%

LRB Market share-DPS 11.30% 11.30% 11.30% 11.30% 11.30%

Appendix 2 Customer Satisfaction Scores

2007 2008 2009 2010 2011 2012 2013 2014

Coca-Cola 84 85 84 84 85 84 84 83

PepsiCo 84 84 86 84 85 84 85 83

Soft Drinks 84 83 85 84 85 84 84 82

Dr. Pepper Snapple 86 87 86 85 82 87 86 82

All Others 83 80 85 79 83 84 82 80

Appendix 3 Significant Margins in DPS’ Operating Process

Q1

Mar-31-

2013

Q2

Jun-30-

2013

Q3

Sep-30-

2013

Q4

Dec-31-

2013

Q1

Mar-31-

2014

Q2

Jun-30-

2014

Q3

Sep-30-

2014

Gross margin 57.25% 58.04% 57.87% 60.15% 60.37% 59.23% 58.43%

Operating margin 14.28% 17.69% 19.51% 21.87% 18.60% 21.34% 19.96%

COGS as a % of sale 42.75% 41.96% 42.13% 39.85% 39.63% 40.77% 41.57%

SG&A as a % of sale 40.80% 38.42% 36.42% 36.02% 39.63% 36.30% 36.70%

OCF as a % of sale 5.58% 13.53% 20.80% 17.09% 9.23% 18.95% 20.91%

COGS as a % of sale change -3.13% -1.19% -0.56%

SG&A as a % of sale change -1.17% -2.13% 0.28%

OCF as a % of sale change 3.65% 5.41% 0.11%

http://www.theacsi.org/index.php?option=com_content&view=article&id=149&catid=&Itemid=214&c=Coca-Cola+&i=Soft+Drinks

http://www.theacsi.org/index.php?option=com_content&view=article&id=149&catid=&Itemid=214&c=PepsiCo&i=Soft+Drinks

http://www.theacsi.org/index.php?option=com_content&view=article&id=147&catid=&Itemid=212&i=Soft+Drinks

http://www.theacsi.org/index.php?option=com_content&view=article&id=149&catid=&Itemid=214&c=Dr+Pepper+Snapple+&i=Soft+Drinks

http://www.theacsi.org/index.php?option=com_content&view=article&id=149&catid=&Itemid=214&c=All+Others&i=Soft+Drinks


12

Appendix 4 income statement


13

Appendix 5 balance sheet


14

Appendix 6 Cash flow statement


15

Appendix 7 Depreciation


16

Appendix 8 Operating Working Capital


17

Appendix 8 Debt Schedule


18

Appendix 9 Operating Lease

Appendix 10 DCF Analysis Result


19

Appendix 11 Terminal value

Appendix 12 WACC

Appendix 13 Share Price


20

Appendix 14 Comparable Companies Analysis


21

Appendix 15 Accrual ratio of DPS and its competitors


22


23

Appendix 16 DuPon Analysis


24

Appendix 17

Appendix 18 Capital Structure


25

Appendix 19 Segment analysis

Appendix 19 Margins


26

Appendix 20 Risk


27

Disclosures:

Ownership and material conflicts of interest:

The author(s), or a member of their household, of this report [holds/does not hold] a financial interest in the securities of this company.

The author(s), or a member of their household, of this report [knows/does not know] of the existence of any conflicts of interest that might bias the content or publication

of this report. [The conflict of interest is…]

Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue.

Position as a officer or director:

The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company.

Market making:

The author(s) does [not] act as a market maker in the subject company’s securities.

Ratings guide:

Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next

twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index. A SELL rating is given

when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months.

Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s)

does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any

investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any

security. This report should not be considered to be a recommendation by any individual affiliated with [Society Name], CFA Institute or the CFA Institute Research

Challenge with regard to this company’s stock.

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