1 Investment Manager Went All In On Soda Firm

When an investment manager with $190 million in assets under management deploys 69.7% of their portfolio to a single stock, it’s worth perking up and taking notice. 

That’s exactly what Lexington Partners has done by allocating a huge portion of their fund to Keurig Dr Pepper (NASDAQ:KDP) which invites the question what is it about this drinks manufacturer and distributor that warrants such confidence?

From its flagship Dr Pepper brand to 7UP, Keurig Dr Pepper has an extensive list of brands under its umbrella, 125 in total to be precise. Beyond sodas, it offers beverages that cater to a wide range of consumer tastes, from coffee and tea drinkers to niche favorites, such as Bai and Core.

But what is it that makes the stock special?

The Business of Dr Pepper Is On Fire

If you were to zoom out on the business as a whole you could broadly bucket Dr Keurig into two categories, hot beverages, including coffee systems and pods, and cold beverages, such as juices, sports drinks and sodas.

Keurig is credited with innovating the way coffee consumption takes place by offering convenience and variety in flavors alongside partnerships with major coffee brands. In the world of cold beverages, the portfolio of drinks covers pretty much every non-alcoholic beverage category from carbonated sodas to sports drinks and everything in between. 

Dr Pepper’s beverage model has a level of genius to it. As health conscious consumers veer away from sugary sodas, Dr Pepper has an array of offerings that produce a broad mix of revenues and mitigates risk of any single beverage category underperforming. It also means the company can take advantage of cross-brand opportunities in marketing and distribution.

With its agile response to consumer trends, like the increasing demand for low-sugar and zero calorie options, Keurig Dr Pepper has stayed relevant in a highly competitive environment where companies like Celsius and Monster make valiant attempts to steal market share.

A significant and often under-appreciated aspect of Keurig Dr Pepper’s growth strategy stems from its partnerships and alliances with global coffee brands that enable it to offer a broad range of licensed coffee pods for its Keurig brewers. The collaborations ensure the company can boost its brand appeal and also expand its product assortment.

As it broadens its product portfolio into health-oriented beverages, it has the potential to keep revenues rising even if a falloff in demand hurts the sugary drink products.

It also wins over new customers who are keen to purchase beverages for their health benefits more so than their hydration. For example, the company offers antioxidant-infused drinks, organic teas, and naturally flavored waters that are aimed at promoting health and wellness.

A further expansion strategy beyond product selection is direct-to-store delivery that ensures wide-reaching and more efficient distribution. It also helps the company to maintain strong relationships with retailers and helps to secure prominent shelf placement so products are more available. When it comes time to launch a new product, this approach is particularly beneficial.

Where Keurig Dr Pepper shines really bright is its ability to adapt to changing trends, whether that’s consumer preferences or at-home coffee consumption. In turn these reveal how strong the company is operationally to be able to support demand across different brands on the virtual flip of a dime.

With all that said, how do the financials look?

Is Keurig Dr Pepper Stock Undervalued?

According to 20 analysts, Keurig Dr Pepper is 15.8% undervalued with a price target of $35.78 per share.

That estimate aligns closely with a discounted cash flow forecast analysis that puts fair value at around $38 per share.

It’s worth highlighting however the company’s price-to-earnings ratio is pretty lofty at this time, sitting at 23.0x.

Where valuation concerns crop up is the PEG ratio of 3.27 that suggests KDP is trading at a premium relative to future earnings growth.

For income seekers, some solace can be drawn from the 2.7% yield that is offered until the price and valuation estimates converge. The payout ratio of 58% suggests the dividend will be paid for the foreseeable future without much concern.

Another point of comfort is the share price volatility, which is typically quite low and means investors can sleep easy at night knowing the business model is strong enough to withstand the onslaught of up-and-coming competitors.

If there was one glaring point of concern it is that analysts recently have been leaning more bearish on the prospects of the firm with thirteen of them revising their estimates lower.

Is Keurig Dr Pepper a Buy?

For 20 quarters straight, Keurig Dr Pepper has grown revenues year-over-year, a remarkable streak for any firm let alone a beverage maker operating in a crowded and highly competitive space.

Better yet, that streak extends to earnings before interest and taxes which have also consistently been reported well in the black.

In fact, for a company generating $14 billion in revenues it’s somewhat surprising to see it has just $260 million in cash versus an eye-popping $10.2 billion in long-term debt. It’s not as robust a balance sheet as we would like to see but free cash flows are still solidly in the black with virtually every passing quarter.

With analysts generally bullish and a cash flows analysis supporting their enthusiasm, there are reasons to be optimistic about buying KDP stock. Furthering the bulls argument is the solid dividend yield that is attractive to those on the hunt for passive income.

However, the high PE ratio and, more particularly, PEG suggests some caution is warranted and the time to buy may be nigh but perhaps not now. It’s a great company with predicable and growing revenues, and solid profitability that lacks a pristine balance sheet, and that offers pause to get too exuberant in case the company runs into economic headwinds that hurt beverage consumption. 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.