Year over Year Growth in
Revenues, Operating Income & Net Income for Monster Energy
Monster
Beverage has been able to maintain its operating margins and net margins for
past several years with only exception of compression in margins during 2008.
This supports the fact that company is not growing revenues by compromising on
margins. It competes directly with other
energy drink manufacturers such as Red Bull and with big stalwarts like Coca
Cola (KO) and Pepsi (PEP) to gain the shelf space at convenience stores. Increased
health concerns among consumers with the usage of carbonated soft drinks have
worked favorably for Monster’s favor but recent allegations related to safety
of its products seems to offset the tail wind it had. Figure 2 compares the
operating & the net margins for Monster Beverage against Coca- Cola (KO) and
Pepsi (PEP).
As
business has grown over the last several years so have the reinvestment
requirements – enabling the company to grow its revenues. Management has been very effective in
analyzing industry trends, growth opportunities and making decisions to
reinvest. Figure 4 highlights relationship that exists between revenue growth
and reinvestment rate (Part of Operating Income after taxes which gets invested
back into the business)
Monster Beverage has created a huge brand in the marketplace and is aggressively marketing its products to attract youth to switch from coffee & carbonated soft drinks to energy drinks and turn them into
loyal customers of the brand. Additionally
it is expanding internationally with sales growing in Europe, Japan, Middle
East, Africa and partnering with industry peers to develop a strong
distribution network.
Valuation of Monster Energy
Growth
story for Monster energy moving forward is international expansion but the firm
also faces strong competition from Red Bull which already has an established international
distribution network. Even though the firm currently enjoys strong brand
loyalty, maintaining pricing power at the current margin levels will be a
challenge, as reinvestment requirements for expansion of business starts to
grow. Growth in future for this company is
where the investors need to realize the risks are and factor them in their
valuation methodologies. From a valuation perspective, value generated by
growth can be categorized in three categories
- Growth Rate
Revenue Growth Rate expected for next 5 year is
15.6 %, operating income is expected to grow 16.3% per year for next 5 years.
- Sustainability of growth
Developing a globally recognized brand and
establishing partnerships for scaling up their distribution network provides a
strong competitive edge for Monster.
- Return on capital
Brand loyalty, product mix and appealing
marketing campaign has helped the company earn higher returns on capital
invested. Median ROIC for Monster Energy since 2004 is 47.9% against cost of
capital of 8%. Returns generated over and above the cost of capital reflect
quality growth generated and value creation for share holders.
As an investor we
should know how much we are paying for growth in business and should be
cautious about paying any premium for lower quality growth. Separating value of
assets currently in place from market price helps in determining how much price
for growth is built in the stock price. Using a cost of capital of 8% (Beverage
Industry –US Average), we can see the value of assets in place, value that
growth will add and price we are paying for growth.
As illustrated in the table above, assuming Monster Beverage will only
be able to earn its cost of capital; price of growth comes at 3.7 times the
value which growth assets will generate. At current price level, market is
implying a growth rate of 23% in the operating income for the next 5 years. This
level of implied growth rate seems higher than our expectations of growth in
operating income but Monster’s ability to generate returns far higher than its
cost of capital add value for share holders which needs to be factored in
company’s valuation. Price investors pay for growth is a variable that
investors should pay close attention to. Using the median ROIC which Monster Beverage since 2004,
we come up with value of assets currently in place, value added by future
growth, price we are paying for future growth, intrinsic equity &
enterprise value of the business. For growth oriented investors, entry price
lower than the sum of value of assets & price paid for growth ($62.87) – offers
growth at a reasonable price and provides margin of safety as well.
I
will publish a follow up article highlighting in detail the inherent business
risk for Monster Beverage, quantify
stock price risk with ±1% growth variation , risks reflected in options markets
and relationship which exists between business risk, growth risk and options
market perceived risk
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