Introduction
About six months ago, I published my investment thesis on Monster Beverage (NASDAQ:MNST) (link here), and since then, a series of news events have caused the stock to move like a roller coaster. However, from my perspective, I believe Monster’s long-term potential remains intact, and now more than ever, I think we are facing one of the best times to buy shares of this great compounder in recent years.
Monster’s stock has recently fallen by up to 20%, making it even more relevant to discuss the main events surrounding the company in recent months. The goal of this article is to share my opinion on these events and to attempt to derive a target price using two different valuation methods.
Ever tougher competition
One of the reasons I believe the stock has been declining in recent months is the market’s perception that the energy drink sector is becoming increasingly competitive, especially with the strong emergence of Celsius (CELH). Undoubtedly, this is true; Celsius is a new player that wasn’t a factor two years ago and is performing very well. However, this does not mean that Monster cannot continue to generate long-term value.
Firstly, the energy drink market is expected to grow at a compound annual rate of 8.4% in North America until 2030, 7.2% in Europe, and nearly 15% in Latin America. Although I haven’t found very reliable data for other regions like Asia, it is reasonable to assume that the trend will be similar. The important point is that this market is far from stagnant or mature, and there are still many incremental dollars to be captured. In this context, it is completely logical for other players to want to enter the market and take advantage of this growth.
Monster Beverage is one of the major players in the industry (alongside Red Bull), which allows them to invest the most in new flavors, product lines, and advertising, capturing the majority of consumer attention. Additionally, thanks to their agreement with Coca-Cola, they have access to the largest distribution network in the market, enabling them to place their products in locations others cannot reach. In this regard, it must be acknowledged that Celsius is doing a good job securing agreements with Pepsi in North America and with other distributors worldwide to compete with Monster’s distribution.
Given all this and the excellent execution by the management over the past two decades, it seems highly unlikely that Monster will not be able to capture a portion of the industry’s growth.
Another concern for the market is that Celsius is creating a new subsegment within the industry, focusing more on healthier beverages. In recent years, sugar-free drinks have been gaining traction in the market due to their healthier profile. However, Celsius has taken this a step further by positioning itself as a healthier product that helps with fat loss and contains vitamins and other health-promoting nutrients.
From my perspective, this trend is indeed happening, and Celsius is doing an excellent job of creating a new category. However, I don’t believe this undermines Monster’s thesis at all. Firstly, because Monster has the capability to launch new product lines to compete with these healthier offerings from Celsius. In fact, they are already doing so with the introduction of the Reign Storm line, which so far hasn’t been particularly successful, but it is a first attempt to enter this category.
On the other hand, it is important to remember that Monster has a market capitalization of over $50 billion and could acquire a brand that is positioning well within this category and integrate it into the group to capitalize on some of this growth.
Anyway, even if they don’t manage to capture part of the market, I believe they could continue to grow, as it is unlikely that this new category will take enough market share to prevent Monster and Red Bull from growing. Obviously, the best outcome would be for them to succeed, and I believe that over time, they will. They have already demonstrated their ability to handle such situations effectively, as seen when they transitioned to sugar-free beverages.
Price of raw materials
Another aspect that is affecting the price of Monster is the price of raw materials. In the agreement with Coca-Cola, it is established that Coca-Cola will handle the manufacturing, bottling, and distribution of Monster cans; however, the purchase of raw materials remains Monster’s responsibility. Considering that the rest of the company’s expenses (general, administrative, marketing, etc.) are quite stable, the fluctuation in the price of raw materials has a significant impact on the company’s gross margin. This is an important factor to consider and will be key in the valuation process.
One of Monster’s main costs is the aluminum for the cans. As you can see in the following chart comparing Monster’s stock price with the spot price of aluminum, although not perfect, they have a very significant inverse correlation. When aluminum prices rise, and thus Monster’s gross margin is expected to fall, the stock price also drops. In recent months, the price of aluminum has experienced a new rally, which has again impacted Monster’s stock price.
I do not consider myself capable of predicting the price of raw materials in the long term, so I do not try to factor this into my valuation of Monster. I simply understand that raw materials tend to stabilize within certain ranges over the long term, and although they can obviously impact Monster’s margin in the short term, in the long term, they do not have as significant an impact as to undermine the thesis, as long as they do not skyrocket to exorbitant prices, which is highly unlikely to happen.
Tender offer
A few weeks ago, Monster conducted a tender offer in which it repurchased shares worth $3 billion at a price of $53 per share. The tender offer was successfully completed on June 10, and it was necessary to issue debt to carry it out. From my point of view, I’m not sure if this was the best possible capital allocation, as for instance, the stock is now below $50, so if buybacks had been made in the market these weeks, the effect would have been greater.
However, I believe that the management is sending a message to shareholders that their shares are currently undervalued, and by conducting the tender offer, they are rewarding those shareholders who sell their shares by paying a premium over the market price, but at the expense of the shareholders who stay. Nonetheless, both Coca-Cola and the CEO still hold a significant percentage of shares, so I doubt they are giving away their money. Most likely, when in a few months the stock is above those $53, the price of the tender offer will seem like a better capital allocation than it does today.
I think the management deserves a vote of confidence in this regard, especially considering how opportunistic they have always been with share buybacks. As you can see in the following chart, they have always accelerated the pace of buybacks when the shares were cheapest, such as in 2018, 2020, and 2022. So if they have always been careful with the prices at which they repurchase, I highly doubt they have made a poor capital allocation with this tender offer now.
Valuation and conclusions
For the evaluation, I will use two different methods. First, I will conduct an evaluation using sales multiples, and on the other hand, I will perform a DCF.
Valuing Monster by sales instead of by earnings per share or free cash flow makes sense because, as we just discussed, Monster has fairly cyclical expenses tied to the price of certain raw materials that the company cannot control. By doing so, we are excluding the effect of these expenses in our valuation since otherwise, we would have to use a normalized net margin to avoid distorting our valuation during periods of unusually cheap or expensive raw materials. This is not an easy task, and I believe it is very easy to get it wrong, so using the EV/Sales multiple, in addition to being much simpler, has also proven to work very well over the last decade.
As you can see in the following chart, this multiple is at its lowest point in 10 years, the same valuation as at the worst moment of 2020. While I think it is reasonable for this multiple to contract in the long term as the growth rate decreases over the years, I still believe that an EV/Sales multiple for Monster can be around 7x. Therefore, by buying shares today, we would be securing top-line growth and the potential expansion of the multiple as an option.
For the discounted cash flow analysis, I used a WACC of 9.5%, a terminal growth rate of 3%, and an FCF growth rate of 11%, which I believe will be driven by strong top-line growth and slight margin expansion in the coming years. I used the cash and shares outstanding prior to the tender offer, as I cannot accurately predict these values for the next quarter. Ideally, these two values should be updated when the next quarter’s results are released, but I don’t think the resulting target price will be significantly different from this one. As you can see, the target price is $45.
Another factor that I believe we should consider is that we are witnessing one of the largest drawdowns the stock has experienced in recent years. It rarely falls more than 20%, and currently, we are very close to that level. If we were to see it drop more than 30%, it would be its biggest decline since its agreement with Coca-Cola began.
Taking all these factors into account, I am going to upgrade the company’s rating from “Hold” to “Buy.” Monster has proven to be a compounder that has adapted to market trends for over 20 years, and I do not believe that the emergence of Celsius and the new healthier category within the industry will change this. The market is large enough for both companies to continue growing and generating value for shareholders. In this article, we have seen that Monster is trading near its valuation lows and is experiencing one of the largest drawdowns in its recent history. Therefore, I firmly believe that from these points, Monster will be capable of achieving double-digit growth over the next decade.
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