Back in late 2018, I was playing around with a stock screener, having fun looking at stocks with certain characteristics. As any investor knows, sometimes stocks come across your radar by happenstance, but more often than not, it comes from looking at a large number of companies until you come across something interesting.
One of the companies that came across my screen when I was filtering with different variables was called National Beverage. Having recently done research on The Coca Cola Company and PepsiCo, the name jumped out at me. I had always assumed that those two firms, plus Keurig Dr. Pepper, were the three leaders in the American beverage space. With just those three companies, you have a very significant share of the marketplace of non-alcoholic beverages.
So, the fact that this company appeared at a glance to be national caught my attention. I went to the company website and began to look at their products and SEC filings. When I saw the products it immediately rang a bell. This is the company that was rapidly gaining fame due to their wildly successful La Croix brand of flavored sparkling water.
My wife loved these things, and I grew to enjoy them too as our personal preferences shifted from buying sugary soda to sparkling beverages. We love it because you still get the fizz of a soft drink, but without all of the ingredients that are bad for your health.
We began to always pick them up from the grocery store, and usually in a few different flavors. They sold them in the upscale Whole Foods in our city as well as the local discount grocer Aldi. Their packaging was tastefully designed, and, though they cost a little bit more than your typical pack of soda, were priced relatively reasonably.
My investor mind was beginning to turn...I saw a product that had clear appeal and seemed to be spreading across the country. This was not something that Aldi had offered a few years ago. And I know from having shopped regularly at Aldi for many years that when a brand or style makes it to Aldi, you know it is already popular somewhere else (they typically carry one or two brands for any given item).
After going to the investor relations website I checked out the most recent annual report. When I looked at the 10-K, I saw a wildly enthusiastic letter from the CEO, using phrases like “...one should have that special ‘sidekick’ relationship with their spiritual guardian, and next, be genetically equipped to be the master of their destiny!”
I kept reading.
Next things got a little bit more into the business side of things, “...capturing top place in market performance in 40 of 42 key markets in the United States....leading the natural sparkling water category with such force as to influence the total sparkling water category in the U.S.”
Ok, these are bold claims. What was next?
“Creativity and innovation, plus new geographic distribution advances, continue to fuel our dynamic momentum.”
Ah, ok. There it is. There’s the upper-management corporate language I’m using to seeing in annual reports :p
The CEO certainly had an interesting way of expressing himself. It seemed that he believed that his company, through the La Croix brand, was in some way the savior of the beverage industry, capitalizing on the trend in the United States of people like me switching from sugary beverages to sparkling sugar-free alternatives.
Looking further at the numbers, it was looking like a legitimate argument. Here’s a snapshot from the Selected Financial Data segment of the 2017 annual report:
Though sales increased by a modest 5.6% annually, earnings per share had increased by 22% annually over this four year period. On the surface it looked like there were solid growth prospects, for sure.
Then, you had videos like this one popping up. La Croix was a national phenomenon indeed. People loved it, and sales were growing. By 2018 it had become a part of popular culture in some respects, to the growing crowd of health-conscious consumers.
The shares were rising but it didn’t seem wildly overvalued like a lot of companies its size. It had no long term debt and a decent amount of cash. Things were looking good.
Then I looked at the other company’s products. These are the types of beverages that you may have never heard of, as they are not really found in mainstream retail stores. These are things like Rip It! Energy drinks and Shasta flavored sodas. In my mind as a consumer, they have very little brand value when compared to the mammoth brands like Pepsi or Dr. Pepper.
Ok, I was thinking, if this company has any significant future value then it is going to all be because of the La Croix product line. People seem to love these things (myself included) so it makes sense that sales would continue to rise.
I still wasn’t convinced though. The annual letter seemed weird and it threw me off. I felt like I understood the basic business model but something about it didn’t feel right.
On my wife and I’s next trip to the grocery store over the following months, I paid attention to the other options that were available in the beverage aisle. The first time I looked, there were not many other options than La Croix if you wanted a sparkling beverage with no calories and no sugar content.
Then, slowly but surely the competition arrived.
Nestle came out with a competitive offering. Then Pepsi. Then Coca-cola. Then other, independent brands. Little by little, I began to notice that the sparkling water category at the grocery store was becoming pretty diverse.
At this point, I realized that if the brand had true strength, it would last and continue to thrive in the face of these new entrants. I decided to stop my research there and wait for the story to develop.
Fast forward to over a year later, and the company has come back to mind again. Since my family moved, we live next to a different grocery store chain than before, and they only carry their generic version of sparkling water. It is pretty good, so we don’t feel the need to go to another store just to get La Croix.
After looking at the most recent financials, it turns out that other people don’t feel that strongly about going out of their way for La Croix either, considering there are so many more options now than there were even just two years ago.
Sales grew just 4% between 2018 and 2019. Yet net income actually decreased from $149 million to $140 million over the same period, due to both increases in product costs as well as marketing and administrative costs.
I went ahead and pulled the most recent quarterly report from December 2019. It looks like over the prior six months, the company had just $67 million in net income, compared with the $90 million in the six month period one year prior. That’s a pretty sharp downturn and a bad sign in the face of increasing competition.
When a business grows sales and eventually increases its profitability, it immediately becomes attractive to many investors. This is self-evident - when a business is making lots of money it naturally attracts more capital. Things are going well, and people want a piece of the action.This may be great for trading stocks, which rely on technical analysis in order to predict short term price movements - but is a short sighted approach for long term investments. This is because over the long term, it is the persistent and continually rising stream of cash that a business generates that determines its ultimate value.
If a business cannot continue to grow profits over time, then new investors are getting a lousy deal today by paying for yesterday’s profit growth. The classic investing example is investing in horse and buggy manufacturers at the turn of the 20th century. Even if you analyzed the industry rationally and chose the best company out there, it would have been a worthless investment when Henry Ford came along with the “horseless carriage”.
This metaphor is not an exact comparison to what we’re looking at here with La Croix and National Beverage, but it is simpler. In fact, the current situation with National Beverage is even simpler than a major industry disruption.
National Beverage is relying exclusively on the brand strength of La Croix to carry its company forward. It is relying on good marketing to get people to continue to buy their product over and over again. In order for this to work, what has to happen? Let’s take a look back in time to see how the current leaders in the beverage space developed their brands.
When Coca-Cola, Pepsi, and Dr. Pepper first came onto the scene, carbonated beverages were a new part of American culture. When these three firms started to develop a reputation for quality and good taste, they gradually out-competed most of the other beverage firms in existence. Over time, people began to simply call soda “Coke” and people in Atlanta swear by the fizzy drink that bears that name just as much as many Texans swear by Dr. Pepper.
This is a snapshot of history, but the reality is we are in the 21st century right now. Few companies are creating lasting, intergenerational brand power in this space (at least in the American market of which I am familiar). One of the few is Monster Energy, which has created a powerful stable of branded energy drinks that have been around for sometime now. (With Coca-Cola owning a significant share of the company, I wouldn’t be surprised if they completely bought them out over time).
La Croix, in my view, just isn’t one of those brands. It is a fad that created an emotional connection with people because it was one of the only sparkling products of its kind around that was being heavily marketed. Now, the big players want to come in and steal market share, and they are doing just that. I believe it is because the La Croix brand, while good, is not especially memorable for something that is otherwise a commodity product.
Competitive advantage is only truly tested when competition actually arrives. National Beverage had the benefit of a first mover advantage in the sparkling water niche, and gained some momentum. It is slowly beginning to fizzle out though, because there simply isn’t enough of a strong brand presence to keep people coming back for more when there are well-priced competitive drinks sitting right next to them in the aisle at the grocery store.
Be careful when assessing brand loyalty and strength. Is the brand of a company truly strong? Or, is it just enjoying the fruits of an uncrowded market? National Beverage still has decent financials and a line of products that people, including myself, enjoy - but I wouldn’t expect much from a present or future investment unless the company manages to build lasting brand equity with its products.