Soft Sell

Cadbury Schweppes has put its European soft drinks division up for sale and, despite an improving US performance, analysts wonder if the US division might be next. Joanne Hart reports

The soft drinks market has a global value of more than US$400 billion. It is big and aggressive, but it is also in a state of flux. Economic pressures are mounting, competition is intense and consumers are being encouraged to watch what they eat and drink. With regard to alcohol this means making sure you don’t consume too many units. With regard to soft drinks, it means cutting back on highsugar, low nutritional value carbonates.

This is the environment in which Cadbury Schweppes is operating, a world dominated by two major players, Coca- Cola and Pepsi – the red and the blue, as they are known.

The number three position is not always a comfortable place to be, and Cadbury Schweppes has fought hard to find a niche where it can make an impact on consumers and deliver strong returns to shareholders.

Sometimes, however, even the most strenuous efforts fall short. In September, the group was forced to admit defeat in Europe and put its drinks division up for sale.

And last month, Cadbury Schweppes shocked financial markets when it admitted it would not meet margin targets, thanks to higher than expected costs. Yet only a few days later, the company hosted a major conference for investors and analysts, focusing on American Beverages and talking in glowing terms about its current status and future prospects.

Divided opinions

Financial followers could be forgiven for feeling a little confused. And, indeed, opinions on Cadbury Schweppes vary significantly.

“The shares are over-valued. The US beverages division has performed pretty well but competition is intensifying and it has delivered very little volume growth recently,” says Graham Jones of brokers Panmure Gordon.

“Investors should continue to see strong top-line performance in 2005 and we expect this to carry on in 2006, accompanied by solid margin growth,” says Andrew Wood of US research firm Bernstein.

So what is the real story behind Cadbury Schweppes’ drinks business? Is it an exciting success or is it a mature business, whose glory days are long gone?

A few years ago, the division would definitely have fallen more into the latter category than the former. The US business was supporting numerous brands – Dr Pepper, Snapple, Mott’s, Clamato and many others – and there was significant cost duplication. In Europe, Cadbury’s had offloaded its UK business to Coca-Cola and had bought Orangina and Casera in an attempt to gain sufficient critical mass to compete.

In neither jurisdiction was the company pulling its weight and investors were unimpressed.

But in 2002, Todd Stitzer took over as chief executive of Cadbury Schweppes and shortly afterwards the group initiated its Fuel for Growth strategy, under which it declared an intention to deliver 3%-5% sales growth per annum and margin growth of 50-75 basis points (0.5% to 0.75%). Stitzer also appointed a new head of the US American Beverages division, Gil Cassagne.

“If you go back to 2003, when Gil was appointed, they needed to make sense of the business before they could even start to think about what they would do with it and how they could grow it,” says David Lang of UK broker Investec.

Under Cassagne’s leadership, the business has been streamlined and focused. Marketing spend has been consolidated and US$20 million has been cut from the advertising and promotion cost base. There have been widespread redundancies and the business expects to deliver US$120m of cost savings over the next couple of years.

The renewed focus has delivered results on the growth front too. The business is divided between carbonated soft drinks, such as Dr Pepper, 7-Up and Sunkist, and noncarbonated soft drinks, such as Snapple and Mott’s. The carbonates are sold to bottlers as concentrates, the noncarbonates are sold directly to retailers as finished products.

Dr Pepper on fizzing form

 In both cases, the company is working hard to deliver increased volume growth and in some situations it is succeeding. Dr Pepper is one of the fastest-growing fizzy drinks in the US, with volumes in the first half of 2005 up more than 6%. Diet carbonates are also delivering good performances, with overall growth up more than 15% last year and just over 10% in the first half of this. On the non-carbonates side, drinks such as Mott’s are soaring ahead, while sustained efforts with Snapple are restoring growth to the brand. There are challenges, however.

“In terms of sales, CSAB (Cadbury Schweppes American Beverages) is split 50:50 but in terms of profits, the carbonates deliver twothirds of the profit and the non-carbonates just a third. Yet there is a lot of margin pressure on the carbonates side,” says Jones.

Rivals retaliate

Naturally enough, Coca-Cola and Pepsi are fighting hard to regain a competitive edge after several fallow years so they have increased their global marketing spend by US$400m a year and focused much more heavily on innovation. In addition, their route to market is generally much more effective than Cadbury’s. They part-own most of the bottling companies that distribute their products and these tend to be large businesses with extensive reach. Cadbury has to deal largely with independent bottlers. It does have its own bottling group but this distributes only around 29% of its drinks, while the lion’s share of its biggest-selling brand, Dr Pepper, is distributed by Coke and Pepsi’s bottlers.

“It is heavily dependent on Coke and Pepsi for distribution and this is an invidious situation,” says Lang.

Cadbury’s has also chosen to stay out of bottled water and energy drinks, two fastgrowing soft drink categories in which Coke and Pepsi are competing enthusiastically.

“We only play where we have brand advantage or can build it. In carbonates, we choose to participate in the flavours segment and we own the number-one or number-two brand in virtually every category where we choose to compete. In non-carbonates, we choose to compete in ready-to-drink teas, juices and juice drinks,” comments Cassagne.

Clearly, this decision has some merit, particularly in a market as vast as America, where even as number three, there is money to be made. In the smaller European market, the third position became untenable, hence the decision to sell. The business is expected to fetch more than £1 billion and it has caused some observers to wonder if Cadbury Schweppes will eventually sell its US drinks division too. That hope has driven up the share price in recent months and proponents of that theory point to Todd Stitzer’s resolute focus on delivering shareholder value.

Resolute he may be, but most of the more considered City analysts believe that a break-up is highly unlikely over the next couple of years.

Lang explains, “You can never say never but this company still has a lot of work to do before it can reach its own stated goals.”