The Long and Short

Value in the long end of the KDP curve

| February 23, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Keurig Dr Pepper’s (KDP) fourth quarter and full 2023 results highlighted market share gains across its product portfolio and margin expansion. KDP improved its productivity throughout the year, setting the stage to hit its long-term financial performance targets. While KDP expects 2024 to bring a more normalized pricing environment, its resilient performance should continue. Guidance for this year puts net sales growth in the mid-single digit range and adjusted EPS in the high-single digit range. Given the strong performance and guidance, KDP bonds look attractive relative to ‘BBB’ food and beverage peers, particularly in the long end of the curve.

KDP’s yield curve is steeper than General Mills (GIS: Baa2/BBB) and KDP bonds trade wide to GIS at maturities of 20 years and out. GIS recently cut full-year guidance and maintains a higher leverage target than KDP. While KDP could look to tap the debt market in the near term to refinance its upcoming March maturity, any issuance in the 30-year part of the curve could provide both an attractive entry point into the credit while helping to flatten its curve with an on-the-run issue.

Exhibit 1. KDP Curve vs. Food and Beverage BBB Peers

Source: Bloomberg TRACE; Santander US Capital Markets

Product portfolio showing resilience despite short-term coffee pressure

KDP’s 4Q results saw net sales (ex fx) up 1.1%, reflecting 4.8% net price realization versus a volume/mix decline of 3.7%. For the year, KDP witnessed net sales growth (ex fx) of 4.9% as pricing growth of 7% was partially offset by a 2.1% volume decline. KDP witnessed strong growth in both its US Refreshment and International business, however at-home coffee volumes continue to be pressured. However, management noted that coffee trends are improving as the back half of 2023 was stronger than the first half, with respect to consumption. In fact, single-serve coffee grew as a percentage of total at-home coffee servings in the quarter. Furthermore, Keurig compatible brewers saw meaningful share improvement throughout 2023 with roughly five out of ten brewers sold being Keurig compatible. This is up from four out of ten at the start of the year. KDP ended the year having added roughly 2 million new households to the Keurig ecosystem which is in line with its long-term target.

KDP also spent 2023 rebuilding its margin structure, which produced impressive results. During the fourth quarter, KDP delivered record quarterly gross margin expansion of 450 bp versus the year-ago period. This translated to gross profit dollar growth of 10%. Furthermore, KDP’s operating margin improved at a solid rate. The adjusted operating margin was 28.5% in the quarter, up 330 bp from the fourth quarter of 2022. While not a record for the company, the growth was the best quarterly growth witnessed over the past few years.

Guidance calling for another solid year

KDP expects net sales growth (ex fx) to be in the mid-single digit range. The top line guidance anticipates continued strong momentum in both the US Refreshment and International businesses, with a somewhat muted contribution from US Coffee. Management has turned to strategic partnerships to help foster growth. That said, partnerships are expected to contribute roughly 200bp to the top line growth. Additionally, the top line is expected to also benefit from carryover pricing from 2023. KDP noted that they anticipate the inflationary environment will be more normalized in 2024 and any new pricing actions will be reflective of this. Additionally, productivity savings and reinvestment in brands are anticipated to produce healthy operating profit growth. Higher interest expenses will likely constrain some of the operating profit to EPS conversion, but management is confident that it can produce EPS growth in the high-single digit range for the year.

Management reiterated leverage target

Management reiterated its long-term net leverage target range of 2.0x-2.5x on the earnings call. KDP’s capital allocation priorities remain intact with reinvestment in future growth first, followed by further strengthening of the balance sheet and then returning cash to shareholders via the dividend and buybacks. While KDP largely likes to balance all three priorities, management noted that some years they may over allocate on a particular priority. That said, shareholder returns were an area of focus in 2023 and consumed roughly $1.8 billion of capital. KDP saw value in their stock and repurchased roughly 22 million shares during the year.

KDP ended the fiscal year with net leverage of 3.1x, which was flat sequentially. While debt increased $440 million in the quarter, leverage remained flat given the improvement in EBITDA. KDP’s leverage target remains below peers with most packaged food companies target leverage in the 3.0x area, including GIS.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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