Establishing
that the concept has been around for quite some time does not help answer the
question that many investors have in mind about Sodastream: ‘Is this a fad, or
could this be a disruptor of long established bottlers such as Coca Cola &
Pepsi?’ A few retail investors-oriented research firms touting Sodastream stock
seem inclined to believe that there is little in the way of an almost inevitable
multi-year expansion.
Israeli-headquartered
Sodastream International is a leading enterprise developing,
manufacturing
and selling home beverage carbonation systems worldwide. Its business model
appeals very much to investors in that it resembles the razor/razor blades,
which made the fortune of companies such as Gillette, whereby high-margin
consumables are sold to repeat customers.
In
Sodastream’s case, the carbonation system is sold in the USA at prices ranging
from 69$-200$ depending on design and features, while refill CO2 canisters
after first purchase can be swapped when emptied for new ones at around $15. The
company’s turnover is further fuelled by the distribution of a great variety of
syrups, many of them licensed by well-know brands, sold in bottles or mono-dose
caps to dissolve in carbonated water.
The concept of a home made
carbonated drink is know from a long time, as it originated with G. H. Gilbey,
a gin distiller who came up with the first system in 1903. Although the first
commercial systems were already marketed in the 1920s, the first home systems
were sold only in the 1950s and became very popular in the 1970s and 1980s.
The bull case is predicated
on seemingly simple premises: geographic expansion through a broader
distribution network (especially in the USA), product innovation and increasing
market penetration thanks to multiple partnerships with well-known consumer
brands offering an ample choice of drink flavourings.
As a corollary to that,
either Sodastream’s market valuation is too cheap, if compared to the
low-single digit growth expected from the majors, or it will become a take-over
target for anyone keen to expand in this promising market. The answer is not a
straightforward one, as we all know that its previous success has not withstood
the test of time.
Sodastream’s model is
appealing to many consumers for the convenience it provides for making your own
fizzy water and flavoured sodas at home, without the trouble of carrying often
much weight. Moreover, higher awareness nowadays for environmental issues
allows Sodastream to build on a greener company image than its competitors,
thanks to its lower carbon footprint due to less recycling required.
Sodastream CO2 canisters
carry a proprietary valve, which allows control of their distribution network
and price. The logistics of taking back empties and selling (technically
leasing) back to customers the filled ones do represent a barrier to new
competitors. On the other hand it is an issue for customers who have routinely
to rely on the closer distributors for the swap, but also for small retail
outlets, which do not enjoy the economies of scale of larger distributors to
deal with this process.
Canisters can refill between
60-130 litres, according to the company, depending on how much fizz is used. If
we add the cost of flavourings it is probably fair to say that the cost a
Sodastream drink is about the same (or slightly higher) as a major brand large
bottle, without taking into consideration the quality of tap water.
Sodastream generic branding
for soda syrups, with the exception of a few licensed deals, does not provide
yet as much brand recognition as the global brands. More marketing investment
on this front should probably be required to strengthen its brand awareness,
but that would also inevitably pose a cash flow problem.
Competition from the likes
of Pepsi and Coca Cola could become much more fierce in the future. Global
brands have deep pockets and it would be wrong to assume that they will not make
any move against Sodastream should they keep on grabbing more market share.
In fact, Coca Cola is rapidly
introducing Freestyle Soda machines across many establishments in the USA,
competing directly with Sodastream. Other initiatives such as the recent
original launch of a Coke bottle made of ice represent a clear sign of
environment awareness and innovative thinking from the major brands.
Even relatively unexpected
competitors, like Green Mountain Coffee Roasters in the USA, have recently
identified the ‘make your own soda market’ as a target and are launching their
own carbonated system. In Europe, it is no coincidence that an intense
Sodastream marketing campaign in Italy is coinciding with rising competition
from companies undercutting their lucrative refill canisters at much lower
price points.
One further threat could
also come from DIY carbonator systems. Such homemade devices could bypass a pricier
refill with Sodastream for a fraction of what the company is charging. A simple
Internet search can provide ample choice to choose from amongst different DYI
systems, which allow using even bigger and cheaper CO2 canisters.
Sodastream is unlikely to be
a fad, in fact, it’s been about too long to be truly called a fad, but any
growing business with high margins and relatively low barriers to entry, sooner
or later attracts new competition. Not only they have to compete for space in
the kitchen with other appliances, but they also have to fend off possible
competition from other domestic appliances manufacturers or global brands
likely to enter the market.
A takeover is still
possible, as speculated in early June when the stock rose above $80 on rumours
that Pepsi could make a move for Sodastream. Such a move appears unlikely
though, given the strains it would bring for the relationship with bottlers. In
all likelihood the share price drop following the recent market rumours down to
below $60 reflects the elevated uncertainty of an imminent takeover.
Logic would dictate that
such move would be more likely to come from a large appliance manufacturer or a
food brand willing to expand in a different segment, rather than a global
beverage brand, which could cannibalise its own sales.
Regardless of any business
scope an acquirer should also be prepared to swallow a meaningful geopolitical
risk, given its significant manufacturing base in the Occupied Territories
beyond the Green Line, which marks Israel border.
Sodastream stock is probably
fairly priced at current levels around $60, as the European business is somewhat
under some pressure and less likely to grow as fast as in the past, while a
rapidly expanding distribution at supermarket and store chains should provide
ample opportunity to expand its footprint in North America.
During its first meeting
with investors in May 2013 Sodastream set a bold $1 billion turnover target in
2016, exciting many investors eager to ride a growth stock which is bolstering
its top-line revenues, having recently signed partnership deals with Honeywell
and Samsung.
Regardless, margin guidance
in the past has provided high stock price volatility like in 2011 and
encouraged the sceptics to heavily short Sodastream (as demonstrated by a very
high short interest, to the tune of 37% of free float).
Recent quarterly results have
provided Sodastream’s bullish investors reason to feel better about its top and
bottom line growth. Nonetheless, while enthusiasm is high on forward guidance
expansion, many investors remain somewhat wary and continue monitoring margin
trends and free cash flow generation, rather than earnings and profits alone.
As such, Sodastream
valuation multiple remain relatively compressed if compared to low-growing global brands such as Coke and Pepsi. Their
free cash flow yield is at about 5-5,5%, while Sodastream has still to show a
positive yearly cash flow return to shareholders, let alone paying any dividends.
A stark reminder that sales
and profit growth alone does not always equate to a higher market
capitalization; the market can usually read through fizzy and bubbly numbers.
