Why Keurig Dr Pepper is more than a pandemic play

Published Wed, Feb 24 20217:28 AM ESTUpdated Wed, Feb 24 20219:17 AM EST

Key Points

The coronavirus pandemic revived Keurig Dr Pepper's maturing coffee business as more consumers worked from home.
The trend is unlikely to reverse completely when the crisis subsides because of the purchases consumers already made of the coffee machines and because of more flexible working routines.
Keurig Dr Pepper shares hit a 52-week high in January, but the stock is still relatively cheap compared with its peers.

Keurig Dr Pepper is no ordinary pandemic play. The company's coffee business received a jolt when office workers started working from home, forming habits that will stick around even after staffers return to their cubicles. Keurig Dr Pepper also stands to gain from the return of demand to other parts of its business. And because of some ownership changes to the shares, it's now the largest company eligible to join the S & P 500 , which could further drive up the stock's valuation. "Coffee is one of the categories that is going to see benefits from the pandemic in the short, medium and long term," said Caleb Bryant, associate director of Mintel's food and drink division. Keurig Dr Pepper has bucked the recent trend of analyst downgrades for food and beverage stocks. In fact, Bernstein, RBC Capital Markets and Jefferies named Keurig Dr Pepper as a top stock pick for 2021. Since shares hit a 52-week high of $33.69 on Jan. 28, they've lost some of those gains, but the stock is still up 9% over the last 12 months, giving it a market value of $44.7 billion. And compared with the competition, Keurig's stock is relatively cheap. It's trading at roughly 19 times its forward earnings, according to FactSet. PepsiCo 's stock is trading at more than 21 times its estimated earnings for the next 12 months, and shares of Coca-Cola are trading at more than 23 times its forward earnings. One key area for growth is the shift to brewing coffee at home. Prior to the pandemic, Keurig's coffee brewer sales were slowing, and industry experts believed that its household penetration was nearing a peak. More private-label versions of its K-cups appeared on grocery store shelves after the patent expired. Consumers were increasingly choosing to buy their coffee drinks from Starbucks or cafes that focused on more sophisticated brewing methods. "People entering the category were aging in — getting their first apartments, going off to college and getting dorm room coffee machines — but there wasn't really any other people entering the category anymore," said Matthew Barry, Euromonitor International beverages consultant. "Things had kind of stabilized." A work-from-home world Starting last March, the trend abruptly reversed. Suddenly stuck at home, consumers bought new Keurig coffee machines or dug theirs out of storage. Sales of its coffee systems segment, which usually accounts for about 37% of its revenue, rose 2.9% during the first nine months of the year, despite significant losses in its office and hospitality sales. In the third quarter, volume of its coffee brewers rose 34%. The company also gained market share for pod coffee machines last year. According to Euromonitor International data, its market share jumped from 76.9% in 2019 to 80.1% in 2020. As vaccines are distributed, some consumers are likely to return to their old coffee routines. However, it is a habit that tends to stick. A Mintel survey of coffee drinkers conducted in April found that 81% of consumers who drank brewed coffee from pods tended to have it at least a few times per week, if not more regularly. Ground coffee drinks and espresso-based drinks from pods had similarly high frequency rates, while cold brew and whole bean coffee were slightly less frequent. Consumers who sank a lot of money into a coffee machine during the pandemic will be more reluctant to stop using it. And if the economy takes longer to bounce back, coffee pods will likely keep selling well because consumers are downgrading from coffee shops. "People are going to grow accustomed to having these premium options available to them," Bryant said. According to Barry, the biggest question for Keurig is where employees will work after the pandemic subsides . If consumers return to their offices for five days a week, their Keurig brewers may become dusty. But many companies are exploring hybrid models, with their workforce only commuting into the office two or three days a week. Tech companies like Twitter have said that their employees will work from home permanently. "That opens up a huge number of at-home coffee occasions, and many of which I think would be captured by Keurig," Barry said. Coke and Pepsi, on the other hand, are mostly looking to energy drinks as part of their appeal to U.S. consumers looking for a caffeinated boost. Both companies stalled their plans to launch versions of their namesake sodas with added coffee due the pandemic, but they marketed the drinks as a more caffeinated, lower-calorie versions of the sodas. After Coke's 2018 acquisition of Costa Coffee, the beverage giant has been rolling out ready-to-drink and packaged coffee, but the U.K. brand lacks the same clout in the U.S. After vaccines are distributed, Keurig Dr Pepper also stands to gain from the speedy recovery of the fast-food restaurant sector. The company's beverage concentrates unit includes the fountain syrups sold to food-service distributors and is the most profitable business segment. The unit reported a net sales decline of 16.5% in the second quarter. By the third quarter, the segment's revenue had fallen just 2.2%. "The business could see a strong recovery as Dr. Pepper is the most widely available carbonated soft drink in restaurants," RBC Capital Markets Nik Modi wrote in early January. Coke's Pibb Xtra, which used to be known as Mr. Pibb, was created to compete with the success of Dr Pepper, but it didn't catch on in the same way. As a result, Dr Pepper has crafted agreements with Coke and Pepsi to place the soda alongside the companies' drinks in fountains, helping it deepen its foothold in food service. The company is expected to report its fourth-quarter earnings before the bell on Thursday. Wall Street analysts surveyed by Refinitiv are expecting earnings per share of 40 cents and revenue of $3.03 billion, a 3.3% bump from a year earlier. An S & P 500 boost Keurig Dr Pepper was formed in 2018 as the result of the $18.7 billion merger between Keurig Green Mountain and the Dr Pepper Snapple Group. It's the third-largest U.S. beverage company that doesn't sell alcohol, trailing only Coke and Pepsi. At the time of the merger, only 13% of shares were available for public purchase. The top shareholder was a subsidiary of JAB Holding, the investment arm of the Reimann family that also owns Panera Bread and Krispy Kreme. Snack giant Mondelez , which had a minority stake in Keurig Green Mountain before the merger, held the second-largest number of shares. But in 2020, both began trimming their stakes through a series of secondary offerings. The 90-day lockup period for the most recent offering expired on Wednesday, which could result in some short-term volatility for the stock as more shares become available. More importantly, however, 58% of Keurig Dr Pepper shares are now part of its public float, making it the largest company by market value eligible to join the S & P 500, according to Bloomberg . Companies need to have at least half of their shares available to the public to make it onto the index. Dr Pepper Snapple Group was removed from the S & P 500 after the merger. If its successor rejoins the index, that could bring another bump to its stock price from passive traders and retail investors buying up its shares.

A Keurig Green Mountain machine

Daniel Acker | Bloomberg | Getty Images

Keurig Dr Pepper is no ordinary pandemic play.

The company's coffee business received a jolt when office workers started working from home, forming habits that will stick around even after staffers return to their cubicles. Keurig Dr Pepper also stands to gain from the return of demand to other parts of its business. And because of some ownership changes to the shares, it's now the largest company eligible to join the S&P 500, which could further drive up the stock's valuation.

"Coffee is one of the categories that is going to see benefits from the pandemic in the short, medium and long term," said Caleb Bryant, associate director of Mintel's food and drink division.