Monster Beverage Stock: There are Problems Beyond the Recent Health Scare

Bargain hunters are buying shares of Monster Beverage (MNST) again, believing the $3.2 billion loss in market capitalization value – more than 30% in two weeks – already discounts potential legal and regulatory risks associated with the marketing of the beverage maker’s signature energy drinks. But trouble lurks elsewhere, as rival challenges to its market share at home and execution problems in new foreign markets will likely hurt operating performance going forward as badly as any FDA probe into health-safety issues. The most recent ugliness in this stock chart seems health-scare-related.

MNST Total Return Price Chart

MNST Total Return Price data by YCharts

Despite attempts to expand the scope and marketing reach of its juice-based and natural soda brands – Peace Tea, Hansen’s Natural, and Blue Sky Sodas – the company remains a marginal player in markets dominated by global players like Coca-Cola (KO), Dr Pepper Snapple Group (DPS), and PepsiCo (PEP).

MNST Revenue Annual Chart

MNST Revenue Annual data by YCharts

Caffeine drives the beating heart of this beast. Non-aseptic energy drinks represented 92.5%, or $550.6 million, of net sales for the second-quarter ended June 2012, up from 91.1% in the prior year. Further, quarterly growth remains highly dependent on continued consumer loyalty to the Monster Energy and Java Monster brands.

Notwithstanding this product-branded dependence, chief executive Rodney Sacks would have us believe that the company is successfully thwarting competitive challenges. Using Nielsen research data, Sacks told analysts on the second-quarter earnings call that on a comparative basis, sales of Monster grew faster than those of its top rivals Red Bull, Rockstar, 5-Hour, NOS, Full Throttle (Coca-Cola) and Amp (PepsiCo). But - at what cost? For the 52-weeks ending April, Chicago-based analytics firm SymphonyIRI had privately-held Red Bull pegged the U.S. caffeinated-king, with close to 40 percent market share and nearly $2.8 billion in sales.

The $8 billion U.S. energy drink market is attracting new competitors too. Kraft Foods Group (KRFT) entered the arena last year with its MiO drink and Starbucks (SBUX) is aggressively marketing its new green coffee extract infused with fruit juices called Starbucks Refreshers. Even venerable Campbell Soup (CPB) is muscling in on the action, expanding its V8 franchise with V8 V-Fusion + Energy drinks and V8 Energy Shots.

Although Monster’s net sales in the quarter grew by 28.2% to $592.6 million, gross profit fell 100 basis points to 51.8% due to a 31.9% increase in promotional allowances. Given the frenzied elbowing for domestic share, gross margins at Monster in coming quarters will likely decelerate further.

Although management will deny it, recent adverse publicity due to the Food and Drug Administration launching an investigation into five deaths allegedly tied to Monster Energy drinks means the company will need to improve its “public image.” Ergo, to get in front of a public debate whose aim would be to restrict sales of energy drinks to minors and/or regulate caffeinated-energy drinks, look for Monster to increase the budgets for two line items that fall under operating expenses: merchandise displays and direct/advertising – pressuring net operating margins well into next year.

MNST Operating Margin TTM Chart

MNST Operating Margin TTM data by YCharts

Don’t look to global markets to relieve the suffering. Yes, net sales outside the United States are growing: Year-on-year they climbed to $124.4 million, or 21% of total sales, up from $78.1 million (17%) in the same period last year. Despite the revenue gain, international markets negatively affected operating losses in the latest quarter by $2.6 million, mostly due to continued product delays in Brazil, Japan, and Korea.

Assuming it can regain its caffeine footing, Monster has the financial resources to work through these headwinds. The balance sheet is clean, with little long-term debt and $870 million in cash and short-term investments. Purchase commitments and contractual obligations are a manageable $156 million, too. And, capital spending through June 2013 is likely to be no more than $50 million, according to management.

Given existing health and safety-related problems, rumors of a Coca-Cola takeover are no longer percolating. And, with the troubled outlook ahead, consensus FY 2013 estimates of $2.45 per share could be adjusted downward. Consequently, selling for only 20 times forward 12-month earnings could prove illusory – making a bargain stock even cheaper in the months to come, based on PE ratio.

MNST PE Ratio TTM Chart

MNST PE Ratio TTM data by YCharts

David J. Phillips is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.

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