Thursday, September 23, 2010

DPS: Getting Sweeter

Dr Pepper Snapple (DPS) shares have sold off in recent weeks.  After hitting a 52-week high of $40.24 in July, the stock closed today below $34.  This equates to a market value of roughly $8 billion. For those who missed an opportunity to buy DPS in the past, it may be time to take a second look. 

Under the direction of CEO Larry Young, DPS is on pace to generate $700 million of free cash flow this year.  This figure does not include a $900 million payment already received from Pepsi (PEP) for a recent bottling deal.

Flush with cash, Dr Pepper Snapple has been raising its dividend and buying back shares.  The dividend has been raised to $1 per share, for a yield of nearly 3 percent.  Try getting that on your money market balance.  On the repurchases, the company announced the following during the Q2 conference call:
Year to date we have repurchased $557 million or 15.6 million shares of our common stock. We are on track to purchase a total of 1 billion of our stock in 2010 subject to market conditions. On July 12, our Board authorized the repurchase of another 1 billion of common stock. This new authorization should cover our repurchase activity to the early part of 2013.
In response to a question about the amount and timing of future share repurchases, CFO Marty Ellen said:
[Share repurchases are] going to consume whatever, I will say, discretionary cash flow is and I define discretionary as after our dividend, of course. We bought that 15.6 million shares so far. We are looking at another in total $350 million worth of repurchases right now for the third quarter in total, and as you think about your models and your numbers, you can sort of assume that we will buy back whatever our discretionary will allow us to do, and as I said in our prepared remarks, our crystal ball says we have got authorization now to carry out through the early part of 2013.
At the time of the call, Dr Pepper's buyback authorization stood at roughly $1.5 billion.  If the company follows through with its plan to repurchase $350 million worth of shares in the current quarter, that will leave $100 million per quarter between now and Q1 2013.  Excluding dividends, this would seem like a conservative estimate for what the company calls "discretionary cash flow".  This assumes that aggregate and relative capital expenditure trends remain unchanged.  Capex is currently split 50/50 between maintenance and new investment capex.

Given the recent stock swoon, don't be surprised to see the company be more aggressive in the short run regarding buybacks (and perhaps even dividends).  Why?

In addition to the $900 million Pepsi payment, Dr Pepper also expects to receive $715 million from Coca-Cola (KO).  The beverage giant's purchase of Coca-Cola Enterprises' North American assets triggers a change-of-control clause in an existing bottling deal with Dr Pepper.  DPS' current capital allocation plans clearly don't include this likely (but not yet received) payment.  Good new for Dr Pepper: the CCE deal seems to be proceeding according to plan with a closing sometime before year-end.

According to recent pronouncements, Dr Pepper is planning on $250 million in dividends and roughly $400 million in share repurchases a year.  That's approximately $650 million in cash returning to shareholders each year between now and 2013.

This is consistent with management's stated goal -  avoid large acquisitions and return the vast majority of free cash flow to shareholders via "a combination of dividends and share repurchases."

At the current market value, the cash flowing to shareholders amounts to a yield of 8 percent.  The closing of the KO/CCE deal and the resulting cash payment could provide an additional positive catalyst for Dr Pepper.  This could possibly lead to an increase in the explicit (and implicit) yield shareholders can expect from DPS shares.

Either way, Dr Pepper's lower stock price ignores these attractive fundamentals, offering value for existing and prospective investors alike.

Disclosure: Author owns DPS shares.


  1. quick comment that why does the management think that debt level at 2.5 Bil is the target? why not reduced it further?

  2. Sam, It's called optimizing your capital structure. Given how cheaply the company can borrow, it makes sense to have some level of debt. If people are willing to lend you money at ridiculously low rates, take it!

    That said, I don't know the exact mathematics behind that specific level of debt, but that is the philosophy behind it.

    Best, TLVI