FA Alpha Daily

It’s crunch time for this major beverage company

High-interest rates and supply chain disruptions made it more expensive for Keurig Dr Pepper to service its debt obligations. In the face of stiff competition, the third-largest beverage company piled on debt to fund marketing, distribution, and acquisitions. In today’s FA Alpha Daily, let us explore how a large market capitalization may be masking underlying financial risks.

FA Alpha Daily:
Wednesday Credit
Powered by Valens Research

Rating agencies often favor big companies, seeing them as “too big to fail” due to their large market presence and influence. They believe that these big companies have enough resources to weather tough financial times, which usually translates to better credit ratings.

Keurig Dr Pepper (KDP) is one such large company, standing as the third-largest beverage company in the U.S.

It came into existence through a significant merger between Keurig Green Mountain and Dr Pepper Snapple Group. According to Dealogic, this merger marked the biggest nonalcoholic drinks deal on record.

This fusion of giants brought a variety of products like coffee, soft drinks, and juices together under one brand, marking a notable expansion in the beverage industry.

In the competitive business landscape, Keurig Dr Pepper faces stiff competition from other beverage makers.

To keep ahead, the company must invest heavily in marketing to ensure product visibility. It is critical for Keurig Dr Pepper to create its brand, establishing a name that consumers trust and prefer.

Additionally, it is critical to build effective distribution channels to guarantee the continuous availability of its items in the market.

All these steps are capital-intensive, explaining part of why the firm has taken on debt.

The company also charted a growth trajectory by acquiring other businesses, which too, necessitates funding. These acquisitions aim to expand its product range and reach a broader customer base, but they also require a significant financial outlay, often sourced through debt.

Now that interest rates have gone up, paying off debt has become more expensive for Keurig Dr Pepper.

Although its large size may offer some leverage in refinancing its debts compared to smaller entities, the high interest rates inevitably translate to higher costs.

The increased cost of refinancing could dent the company’s profits, and also escalate the cost of operations and meeting other financial obligations.

Furthermore, in the post-pandemic period, supply chain disruptions have exacerbated the company’s financial burden.

Keurig Dr Pepper had to deal with these interruptions, which resulted in higher prices for inputs, transportation, manufacturing, and personnel. The geopolitical uncertainty affecting commodity and energy prices further complicated the situation.

These challenges, when coupled with multiple debts in a high-interest rate environment, present a gloomier picture for the firm’s financial health.

So, while the large size of Keurig Dr Pepper might seem like a shield, the high interest rates and the costs associated with its debt could manifest as significant challenges.

Nonetheless, rating agencies continue to have faith in Keurig Dr Pepper, describing it as “too big to fail” and thus maintaining a positive outlook on the company’s credit position.

Thus, S&P gives Keurig Dr Pepper a “BBB” rating. This rating indicates very low credit risk over the next five years, firmly placing the company in the safe investment grade category.

Given its current financial situation and forthcoming debt maturities, we believe that a riskier credit rating is more appropriate.

We can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (“CCFP”) to understand how the company’s obligations match against its cash and cash flows.

In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

The CCFP chart shows that Keurig Dr Pepper’s cash flows are not enough to serve its obligations going forward.

The chart shows that the company’s huge debt maturity and other obligations exceed its cash flow this year, which might put it in distress.

Additionally, the consistent debt maturities going forward will continue to eat into its cash flows.

And in the case of refinancing, the high interest rate environment we have currently could make it more costly to refinance debts. Overall, these factors show that there is much greater credit risk related to the company than rating agencies consider.

That’s why we’ve assigned the company an “HY2-” rating. This rating places the company in the high-yield basket and implies that a higher credit risk is accounted for.

It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.

To see Credit Cash Flow Prime ratings for thousands of companies, click here to learn more about the various subscription options now available for the full Valens Database.

SUMMARY and Keurig Dr Pepper (KDP:USA) Tearsheet

As the Uniform Accounting tearsheet for Keurig Dr Pepper (KDP:USA) highlights, the Uniform P/E trades at 18.9x, which is around the global corporate average of 18.4x, but below its historical P/E of 21.6x.

Low P/Es require low EPS growth to sustain them. In the case of Keurig Dr Pepper, the company has recently shown a 11% Uniform EPS shrinkage.

Wall Street analysts provide stock and valuation recommendations, that in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Keurig Dr Pepper’s Wall Street analyst-driven forecast is for a 16% EPS growth and a 7% EPS growth in 2023 and 2024, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Keurig Dr Pepper’s $30 stock price. These are often referred to as market-embedded expectations.

Furthermore, the company’s earning power in 2022 was 8x the long-run corporate average. Moreover, cash flows and cash on hand are below its total obligations—including debt maturities and capex maintenance. The company also has an intrinsic credit risk that is 190bps above the risk-free rate.

Overall, this signals a moderate credit risk risk.

Lastly, Keurig Dr Pepper’s Uniform earnings growth is above its peer averages, but is trading below its average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

This analysis of Keurig Dr Pepper (KDP)’s credit outlook is the same type of analysis that powers our macro research detailed in the member-exclusive FA Alpha Pulse.

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