Monday, December 19, 2005

Cadbury Schweppes (CSG)

I've previously written about the merits of gum/confections co. Wrigley (WWY). Even though I remain positive on the company, I'm not sure that, at current valuation levels, the risk/return is significantly in my favor.

Another confectionery giant that I've started to look at is Cadbury Schweppes of the UK. CSG has ADR's so trading this name won't be a problem. 2004 sales were 6.7 billion pounds with operating profit of 916 million pounds (13.6%). Market cap is about $19.1B and CSG pays a 2.5% yield. At today's close of $37.40/ADR, CSG trades at about 14x consensus 2006 EPS.

The data that I reference below comes largely from the CSG 1H05 report and also the co's most recent business update pr.

In the 1st half of 2005, sales came in at 3.1B pounds, up 6% yoy and op. margins came in at 14.4% vs. 14.5%.

Americas Beverage is the 2nd largest operating segment at CSG with 1h sales of 770mm pounds (up 5% yoy) and op margins of 29.1% (off 30bp yoy). The big carbonated brands here are 7up and Dr. Pepper. Carbonate share in the US was up 70bp in the 1H -- margins down due to heavy promotional support of brands. Launching new non-carbonate drinks (Mott's Plus, Diet Snapple drinks)--marketing spend up more than exp. here too. Sales of bevg. to Mexico up 20% (Penafiel water brand).

Americas Confectionary is the 4th largest op. segment with 1h sales of 457mm pounds but it is also the fastest growing (sales up 14% in 1H, margins up to 13.3% from 12.2%). Key brands here are Halls, Dentyne, Trident. US sales up 12%, Lat Am up 20%) Logistics/IT issues resolved.

Europe, Middle East, Africa (EMEA) is the largest segment (962 million in revs +6%, 12.8% op margin - down 100bp in 1H05). Plagued by weakness in developed Europe. Africa, Eurasia, Middle East had sales up 14% and Russia was up 19%

European Bevgs is a segment that CSG has struggled with (in 1H, sales up 2%, op profit off 2%). This segment is on the block -- transaction expected to close in early 2006 for 1.27 B pounds.

The final op. segment is Asia Pacific. 1H05 revs of 491mm pounds, up 7% yoy, op margins up from 9% to 9.2%. Cadbury chocolate in India has 72% market share (up 200bp). Leading gum share in Malysia, relaunched Cadbury dairy milk in China in 2H2004

2004-07 growth plan
  • Sales up 3-5% constant currency, ex-acq -- in pr, CSG said that they will be near high end for full yr. 2005
  • Underlying op margin growth of between 50-75bp per year constant currency (in 2005, op margins won't increase by this range -- heavy investment in brands, fuel, in 06, this should be better)
  • FCF of 1.5B pounds in four year period ending in 2007
I think CSG's plans for success make sense and are similar to those of WWY, namely, grow sales in the developed markets in the low-middle single digits, invest in your brands and earn high margins. In the developed world, the name of the game is volume growth. So in places like China and Turkey and Malaysia, CSG will establish their brands and set up opportunities for margin expansion.

Speaking of Turkey, CSG will acquire a further interest in the #2 confection co. there. This will allow them to establish a hub in the fast growing region and will also allow CSG to shift some supply of gum (that will make it's way to the EMEA) to a lower cost location.

To further generate cost savings in Europe, CSG will begin building a new gum factory in Poland in 2006 and is also currently investing $30mm pounds in a plant in Mexico (supply moving south from higher cost Canadians).

To sum it up, I like the business, the stock isn't too expensive. It's a defensive idea with a decent dividend. In the next 3 yrs, sales growth of 5% and op margin expansion of even 50bp annually sounds pretty good to me. I don't have funds available at this time but I'll likely do some juggling if we approach $36.

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