Chit Chat Stocks - Monster Beverage (Ticker: MNST) Not So Deep Dive

Episode Date: April 11, 2023

Monster Beverage (Ticker: MNST) produces energy drinks and other non-alcoholic beverages, with strong growth in its energy drink segment, but also facing competition and regulatory scrutiny over safety and marketing practices. At the end of the month, we will publish an Arch Capital episode that will cover the company: Nintendo. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Monster Beverage. Enjoy the show! ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (5:10) Industry | (18:19) Management & Ownership | (22:47) Earnings | (30:20) Balance Sheet | (36:55) Valuation | (38:18) Our Analysis | (39:19) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. All right, welcome in. This is the Tuesday Not So Deep Dive episode on Chit Chat Money. My name is Brett Schaefer, and I'm joined by my co-host, Ryan Henderson. Today on our,

what we call the Not So Deep Dive episode, we analyze one stock by covering its business model, ownership, financials, future growth opportunities, and much more. After you listen to this episode, we hope you get a better perspective on the company and where it sits as a stock and its position within its industry. This month, we are transitioning to covering consumer packaged goods or CPG brands. I think I can name the ones we're doing off the top of my head, but Ryan, help me out here if I forget. Today, we're covering Monster Beverage, which jones monster energy then we're doing pepsi and then we are doing we're doing philip morris next philip morris then pepsi okay philip morris international then for our arch capital episode

we're going to do nintendo which is sort of consumer goods in in a way um with their hardware but and they've got some toys i guess yeah consumer goods slash entertainment slash tech Yeah, video games are a hard one to pin down. Before we dive into Monster, we've been doing these themes for a while. I think we should address, we should talk a little bit about the themes broadly at the start of this, and maybe at the end,

see if our opinions have changed at all. Going into the CPG month, what are kind of your conceptions of the space as a whole? My overview, without going too deep, is you can find some great profitable durable businesses but typically low growth um and you i think a lot of people look at them like this they usually trade at high valuations and you kind of wait wait wait wait wait until they have a low valuation at some point that's my conception maybe it will change after we cover these but that seems to be mine after we covered

monster as well or research monster all right or yeah i would just add i think these can if they are if they are successful i think they can be some of the best businesses in the world and provide some of the best returns as you'll see with monster i think it might be the best performing stock of all time or at least in the last 20 years sorry since yeah since 2000 yeah um Um, so I, I'm excited to see what the like blueprint is for that or discuss what the blueprint is for that and see if it's replicable for other businesses. But, um, yeah, I, I guess I'll leave it at that. Why don't you talk about our sponsor and allow me to share my screen?

Yeah. Okay. Let me, let me do that for you. Uh, today's episode is presented by, can you share the screen? Okay. Today's episode is presented by stratosphere.io. It is our home screen for fundamental research. It is the best web-based research terminal for company-specific metrics like KPIs, segment

revenues, clean data visualizations, as Ryan is sharing for the YouTube and Spotify audience right now that are watching on video. You can chart all the historical financials for a company like Monster Beverage, as Ryan showed earlier there. Their revenue, as we'll talk about during this episode, has been just durable, double digit growth. I think 20% growth for 30 years, which is just astounding. We'll kind of get into why some of these CPG companies like Coca-Cola, like some of the cigarette companies,

and like these energy drink companies can put up that durable growth for so long and how they've been able to expand internationally. But Stratosphere is a perfect way to visualize that. It's a perfect way to supplement your research and save you time and frustration. I think that's the biggest thing that we get out of using Stratosphere is the time and the frustration. And I just saw that they passed 10,000 users, which is great since they've been launched for less than a year. I think any listener to this show would love to try them out and add on and keep them marching higher because we want them to succeed as well. It is much better than the frustrating, old, dodgy stuff you might use at Yahoo Finance. So switch over to Stratosphere.

Use them to track your companies. Use them to research. Okay. That is stratosphere.io. Ryan, let's get into Monster. What is this company and what is their history? Yeah. Monster is more or less the creator and the seller of a variety of different energy drinks. I say more or less just because the manufacturing is still outsourced, but really they develop and sell a bunch of different energy drinks across 142 countries and through really slowly developed or slowly cultivated web of distributors around the globe. And that includes full-service bottlers and distributors, as well as retail grocers, specialty chains, convenience stores, gyms. The majority is through full-service bottlers and distributors that really do it for them. And that's Coca-Cola. They have a giant partnership with them. Yeah.

You'll talk about that in the history in the soon end. Yeah. And if you see, I mean, if you're reading through the 10K, you're going to see TCCC. I think I got the right amount of C's there. a number of times. And that is the Coca-Cola company. And they really dominate the distribution for Monster. However, Monster does go directly to their own stores as well. A lot of convenience stores, a lot of gyms. But yeah, Coca-Cola has really helped bolster that distribution, especially across the globe. But Monster itself breaks its brands into three, basically three reporting segments. There's one extra one, which is really just they develop some

of their own flavors. But the three are Monster Energy Drinks, Strategic Brands, and Alcohol Brands. Monster Energy Drinks, this includes all of Monster's sales of ready-to-drink bottles. So think your typical Monster can. And it's all the different variations. So there's the classic Monster with the green logo on the black bottle or the black can. There's the white one that's very popular as well, all that kind of stuff. This also includes Java Monster Coffee, a whole bunch of different variations of that as well, Monster Dragon Iced Tea, and it's Rain brand, which they introduced in 2019. A lot of people don't know that's under the Monster umbrella, but Rain, which has been really successful growing their own, carving out their own market share

within energy drinks as a whole is included there as well. And overall, Monster Energy drinks as a percentage of total overall revenue is 92%. So this really dominates the bulk of the business. The second one here is strategic brands. This segment refers to Monster's sale of concentrates or beverage bases to their bottling partners. So in this case, the bottling partners will actually combine it with some sugar or flavor, typically whatever Monster tells them to combine it with, and then they'll kind of do the sale or they'll pass it on to the distributors. But some of the recognizable names in this category include Burn, Full Throttle, and NOS.

NOS is probably the most popular that I can think of from that category. I believe Byrne actually belonged to Coca-Cola initially and was transferred in the deal they did in 2014, but I'll talk about that in a second. That accounts for six percent of new, really kind of small. And then the third one, and this one's maybe the one people are optimistic about or maybe where some of the most opportunity lies, is the alcohol brand. So in 2022, a year ago, Monster acquired Canarchy, which gave them an entrance into the alcoholic beverage category. This category includes all sales of either kegs or ready-to-drink alcoholic beverages. Some of the brands people might know that they acquired were Jai Lai, Dale's Pale Ale. They have the apricot, Hefeweizen.

And then they have a line of hard seltzers that really aren't that popular, or they weren't that popular prior to the acquisition, but they're working to kind of revamp that brand. And really, it feels like they're buying it more for the infrastructure, the distribution network, because I think it requires its own sort of specifications with whenever something contains alcohol. But that only really accounts for 2% of revenue. That was excluding a month of reporting, but really, it's still small relative to the overall Monster business. And then as for the manufacturing side of things, as I mentioned earlier, Monster still outsources that process to third parties. This means that Monster is responsible for purchasing the ingredient, the flavors, which as I mentioned, they develop a lot of their own flavors, the juices. They got to purchase the aluminum for the cans.

They got to purchase the bottles, the caps, and those are delivered to their bottlers and co-packers, which go out and actually assemble them. And so those are the largest contributors to cost of revenue for Monster. And as we'll talk about in earnings, it's really been the driver of margin compression because those costs have gone up over the last year or two. And they haven't necessarily passed it through directly yet, or it's taken some time to pass it through. So those are big ones. Supply chain, they move a lot of inventory. So they're responsible for that, which has been expensive as well.

increasingly expensive over the last couple of years. So margins have come down a bit because of that, but that's sort of the basics of the business. Do you think I'm missing anything there? I don't think so. No. We'll talk about the potential, the upside, the downside, if it's risky of going into the alcohol business during the future growth opportunity. So we'll hit that one again and potentially we'll hit the, you know, how do I say it? Whether it's just going to be more of an energy drink story this decade as well and whether the alcohol is actually going to matter. But yeah, no, I think that's it. Okay. Let's go through some of the history before we get into the specifics of the business. But

there's actually some fascinating history here and some of it is kind of hotly debated. So I'll talk about that in a second. But the company was officially founded in the 1930s by Hubert Hansen and his sons with the focus of selling natural juices to film studios and retailers in Southern California. I'm not sure why the focus was on film studios, but it was. And if you recognize that last name, Hansen, it ultimately ended up becoming Hansen's natural juice, which a lot of people... I don't know if that was just a West Coast thing, but I still remember that brand pretty distinctly. It was really popular, I thought, growing up. I don't know if it's still around, but yeah, that was sort of the origins of the

business. And that company went through a bunch of different corporate changes, kind of got passed down to his kids, Hubert Hansen's kids. And then ultimately the business ended up going bankrupt or filing for bankruptcy in 1998 or 1988, I should say. And it was acquired by the California Co-Packers Corporation. And then it was afterwards, it was renamed Hanson's Natural Company. And then it was sold to the now current management, which were two South African entrepreneurs, which Brett will talk about in a little bit. But from there, the business really starts to take a shift. That's when shift, I hope I pronounced that right. And it kind of becomes an interesting story because they really started to grow the Hanson's Natural side.

And then in 2002, April of 2002, Hanson's Natural launched the Monster brand. Keep in mind, the year prior to that launch, so 2001, the company did $92 million in sales and $3 million in net income. So this was a $3 million net income business prior to Monster. For context, this year, so 21 years later, Monster generated $1.2 billion in net income. So in the last 21 years, they've gone from $3 million in earnings to $1.2 billion. Probably the most successful story over the last 21 years that I can think of. Maybe, you think Apple trumps that?

I don't know. Yeah, yeah. I mean, on a size, yes, of course. But within the CPG space, this is the most successful new brand within CPG the last two decades. And something like tech, yeah, Apple. I mean, Apple's definitely bigger, but yeah. So anyways, the controversy is really around the early branding and its ties to the war in Iraq. So rumors are that the company used – and this is not even necessarily rumors.

It's very clear. They used military-like branding to appeal to the pro-war sort of patriotism that was rampant kind of right after 9-11. And it was very sort of aggressive – I don't want to say monsterish because it sounds like a pun, but like intense branding, which I think really appealed to that. And so I found this quote. There was this long kind of thesis paper on some of sort of the ramifications of this and how they benefited from the pro-war kind of sentiment at the time. it says the camouflage pattern on the monster assault flavors can with its accompanying exhortation to declare war on the ordinary and the company's wide use of militaristic and violent rhetoric would seem to necessitate an acknowledgement of u.s military action since 9-11

and since monster started in quotes cooking up its killer energy brew the following year however even while employing militaristic imagery the assault 15 cans text includes a written disavow of being for the war or against the war so it doesn't have any reference and monster denies any political standing on any war however i mean they really care why is i don't know why this is a big deal so what if this is what the soldiers want to drink is it supposed to be illegal no it's just how they kind of benefited and probably someone that was not didn't have a similar stance and it was just kind of a study of how they benefited um because this was and and you listed that business wars podcast like this was how they got such tremendous product market fit

yeah and for listeners the biggest context i would want uh to that anyone needs to know is that red bull came onto the scene earlier and they had more of a you know coastal richer people you You know, you have the Red Bull, not soda. You have the Red Bull, vodka Red Bull at the clubs. It was more of a, okay, I'm a more of a wealthier partier type. And Monster wanted to go for the people that looked at Red Bull and kind of scoffed at that expensive drink. Although they still charge the same amount where both of them are higher priced than a soda, a juice or something like that. Yeah, it was kind of – it feels like Red Bull targeted more like the fun thrill as opposed to Monsters, which was like intense kind of – I don't want to say scary.

Extreme sports. Extreme. Extreme sports, yeah. So I don't know if – I guess I don't know if they were like, whatever, pro-war, it doesn't really matter. But there were clearly appeals to that sentiment. For example, they had a partnership with Call of Duty early on. You hear them reference the US military a number of times in the 10K as a big customer. And so that really did help the company find remarkable product market fit.

And over the next decade, so from 2002, the launch to 2012, the energy drinks really helped the business grow. And by 2012, it was the largest segment for them. And so they renamed the company Monster in 2012. And two years later, 2014, Coca-Cola bought a major stake in the business for just over $2 billion in an attempt to make Monster its, in quotes, exclusive energy play. I think this was, well, hindsight, a great move by Coke. But along with the deal, Coke transferred their energy brands to Monster, and Monster handed over their non-energy brands to Coke. And so that's where Monster got, I think it was Burn and one other one, really not a big part of the business.

But what they really got was Coke's distribution capabilities globally, and that's been a massive driver domestically for Monster over the last decade. I put in here, if you read the newsletter, if you subscribe to our sub stack, I've got a map of the distribution that Coca-Cola has. It's basically everywhere on the globe except Africa and some of the Middle East, but everywhere else seems to be pretty much covered. Yep. And I will say again, subscribe to the newsletter to get some of the charts, info, all the data we may talk about on the show. It is free and goes along with every Not So Deep Dive episode. The link is in the show notes.

Okay, let's get to industry competition. Pretty simple one, but I think I was surprised at least without studying this industry beforehand how new the category is. because Red Bull, I think it really became maybe not a worldwide phenomenon, but somewhat of a worldwide phenomenon with Red Bull in the 90s. And then it didn't even start becoming, I'm talking about the energy category in general, the energy drink category, the carbonated one, whatever you want to define it, didn't really become a global one until maybe 10, 15 years ago. It kind of it became a mainstay in a lot of people's lives. If we look at the energy drink industry today,

it is quite large. It's estimated to be sized at about $86 billion around the globe and is growing at just below 10% annually on a revenue basis. However, the way I like to look at it is Monster Beverage or these Monster Energy drinks, they're actually competing in the entire packaged drinks market, which is mostly non-alcohol, as well as with coffee. So I think of them mainly competing with sodas and coffee or tea or juices for someone's drink. And this total at industry is estimated to do over $200 billion in annual revenue that analysts expect to double this decade around the globe with a lot of international growth. The majority of industry growth is coming from the non-alcohol and non-hot drinks. So Monster Energy, the energy drink

companies are taking market share, and it gives these companies a nice little long-term tailwind. Now, it's not guaranteed that this tailwind is going to continue into the future, but this is the tailwind where Monster Energy was able to grow at a 20% revenue clip because the industry was growing at 10% a year or higher, and they were gaining market share. We'll talk about their market share probably throughout this episode. I don't know if we could count on them gaining any more market share around the globe, but they are one of the leaders now and it has turned into quite the duopoly. Now, if we look at competition, the main one is Red Bull and then there is Rockstar, but Rockstar is really fading into irrelevance. There also is competition from the

non-energy drink stuff. I think of coffee, soda, Coca-Cola and Pepsi for what people grab for that daily drink. I think the big question investors can ask is how much of the soda drinking can it replace? How much of the coffee drinking can it replace? That's how I view it on the long-term opportunity in the competitive landscape. And then for the newsletter, I have a nice graphic that shows in 2020, the market share, it's somewhat similar across the energy drink brands. Although someone like Celsius and the healthy drink ones, we will talk about them during the low light section and their risk and maybe how we see that potential for the market. But yeah, if we look at the market in 2020, Red Bull had 43% of the market,

Monster had 39%, Rockstar had 10%, and then Amp and Nos each at 3%, and then everyone else is smaller. And Rockstar has declined since then. So really, Red Bull and Monster dominate this industry with more than 80% market share. It has turned into a duopoly, and we'll maybe talk about later again during the analysis section on whether this has turned into a coke pepsi dynamic or if the industry is a lot more fluid with competitors than the soda market but let's go to management ownership or ryan you have anything to add before i go to management ownership yeah the other thing is monster technically is larger now um if you include monster rain and nasa's one uh compared to Red Bull, correct? Yeah. They had a chart. If you look at their investor day, they have a lot

of slides. However, they're just really hard to put into the podcast as visually, they're not the best, which I actually think is kind of bullish for their management team because when the slides are so good and the shareholder letters are so good, I think, hmm, how many people did you have working on that? That might be a little inefficient for your research. But yeah, if you combine those, I believe all the monster beverage energy brands outpace Red Bull, but they're neck and neck. they're pretty darn close and it's been fairly stable. Although again, we will talk about Monster has lost a little bit of market share to these health focused energy drink brands, but let's move to management and ownership. Things are going to feel a bit outdated at the moment because we

are at the time of the year in April where we have the new annual reports, but we don't have the new proxy filings for a lot of companies. But I think with Monster, it'll be fine. So Monster's beverage is run by two men, Rodney Sachs and Hilton Schlossberg. They have been on the board of directors since taking over the company in 1990 and run the company as co-CEOs today. That potentially could be a red flag if that was a new dynamic. And I know they just made Schlossberg the co-CEO, but they essentially said that they just wanted to do what was actually happening under the hood. So these two guys have been running the company together for over 30 years. I don't think the co-CEO thing should be any sort of concern. And I don't think it's an

indication that Sachs is deciding to leave or planning to leave, excuse me, because he has been out with the company as the CEO since 1990. And then if we look at the rest of the executive team, I don't need to list them out. You can go read it all yourself. But they've all had long tenures at the business, which I think is a good sign. They actually just bumped up their long-term, I believe it was the marketing guru. I forget his name, but his last name was Hall to the board of directors. And as Ryan mentioned, Coca-Cola has a big stake in this business. So they have a few members on the board. I want to have a discussion question here. What do we think of the frenemy relationship between Coca-Cola and Monster? Was this a good decision by Monster to sort of say,

hey, look, you can get 20% of our business. You can get a big amount of the upside here with the company if you own 20% of us, but you're going to stay out of the energy drink markets. And they kind of eliminated one of the key competitors or potential competitors. Yeah, I mean, I think the answer is obvious since we've seen the results since that deal was done. They're huge beneficiaries from this deal because of both eliminating the competitor, but also obviously the distribution with Coke's kind of network. Yeah, and I wonder how this relationship is going to change or not over the next decade as Monster seems a bit intent on going out of the energy drink category and expanding into this alcohol stuff, which I know Coca-Cola doesn't have a huge presence in, but they are going into the water category as well, which Coca-Cola does have a big presence in

and maybe they expanded some other stuff. And I wonder if Coca-Cola is going to be mad at them about that and that might upset them, but we'll see. Hasn't had any effect so far. If you look at their executive compensation, they have the standard boilerplate compensation consultant BS. I will say that seems to be in every company. There was a good tweet from an account, I forget who it was, on Twitter saying that

it is not surprising when executives consult another company to make their compensation schemes that they keep overpaying them, something along those lines. And that's the case here. So executives get base salary, annual bonuses based on adjusted operating income targets, and then long-term performance stock units based on adjusted earnings per share targets. It's fine. It's not great, but it's fine. There are some concerns here. These are a little bit, the compensation is not a big deal, but it wasn't my favorite. If we look at the total cumulative executive compensation across the board, it was $40 million in 2021,

or about 1% of annual gross profit. So no concern about maybe a situation where we're getting paid hundreds of million dollars a year. Ryan, I saw you on mute yourself. Do you have something to add before I go into my red and yellow flags I found on the proxy statement?

Yeah, I was just going to say, like the adjustments, obviously, we don't prefer adjusted numbers, but because stock-based compensation is really kind of negligible, the adjustment or the difference between adjusted operating income and operating income

is very small at this business. Yep. Yeah. Yeah, it's fine. It's fine. But I did see some major red and yellow flags. First, I had the compensation based on adjusted numbers. That's just a minor one. Second one, the two, and I'll call them the founders here because they really did found this business. They pay themselves a ton in salary and bonuses when they are already immensely rich promoting the stock. Now, they're the ones that created basically, what, $55 billion in shareholder value out of nothing. So sure, fine. You can pay yourself a lot, but Buffett created what? $600 billion in shareholder value out of nothing. And he pays himself $100 million a year and earns his money

in an honest way. 100,000 a year, right? Yeah. Oh, I said 100 million. Oops. Yeah. 100,000. Third one, the founders get paid fees. I've never seen this before. This is the most greedy and maybe unethical thing I've seen from this one is the founders get paid fees for two social clubs by the company. Didn't like that one at all. Fourth one, there are related party transactions. And the most concerning one is that Sachs,

who is the CEO, charters his private jet back to the company and forces them to pay him, which I just, you know, lend it out for free, man. Let's just not. right? I don't know if they're required to make some payment there, but why don't you just get a payment from another company? I don't like the related party transactions for stuff.

And when I looked at the services that they were getting provided that they described, don't need to put through all of them here. They were things that there are hundreds of different companies out there. And the fact that they went for five or six times for related party deals on some of these things, just not the best. And then they also make the ownership stakes of the two founders incredibly confusing to parse through. I didn't like that, but I don't think that's a huge deal. My read on the situation is that there's no means going to tear the business down. It doesn't mean the stock's going to collapse or anything like that. It wasn't all fraud or anything like that. But my read is that there is a lot of greed here from these two,

unnecessary greed. They're already immensely rich. Why don't you just be a little bit more i don't know rewarding for your long-term shareholders what are your thoughts ryan on seeing those things yeah i mean the i have seen some of the stuff before like i've seen management get their gym memberships paid for i forget what business i was looking at equinox is expensive nowadays 300 bucks a month you know but no yeah i mean that's never that's never good either i don't like that security i've seen the security a lot right security is a big one the But I think you get a pass when – this should not omit you from owning the business. No, yeah, yeah.

I think managers get a pass, too, when obviously they've done what they've done and then also when they own 20% of the business, roughly. Yeah. Well, it doesn't mean it's not unethical. I still don't – Sure. It still rubs me completely the wrong way. But yeah, if we look at ownership though, to close out this section, Coca-Cola owns 19% of the company, Saks and Schlossberg own around 9% each.

Those are the largest shareholders outside of the, whatchamacallem, the passive ones, the passive aggregators. Okay, Ryan, let's hit earnings. What did the last full year of this company look like? Yeah, the other thing I'll add, and I forgot to throw this into the history, but I usually don't, but I think it's important to do it for this company. The stock performance since the introduction of the Monster brand, so April of 2002, the stock is up 120,000%. That means $10,000 would be worth $12 million today.

This is by far the best performing stock since 2000. And I mean by a long shot. Apple, for reference, is up 16,000% since 2000. So 120,000% versus 16,000%. I mean, I would still take Apple's returns, but it's kind of just mind-boggling to look at some of those returns. Let's talk about the earnings for the full year, though. $6.3 billion in net sales.

They do have a gross billings figure, which basically, it isn't that important. And it usually is just in line with net sales, but it just is an add-back with promotional activity. So just look at it on a net sales basis. That's the thing that matters. 50% gross margin this year versus 56% last year. A lot of that came from, and it started to trickle back upwards in Q4. But a lot of that, like I said, a lot of supply chain pressure and rising costs of aluminum.

They said- Foreign exchange too. Yeah, big foreign exchange. I think 36% of their revenue comes from outside the US. So they do generate a lot of sales internationally, but they did say, without saying it explicitly, that they expect margins to kind of trickle back up to where they were slowly, kind of sequentially over the next four or five quarters. $1.6 billion in operating income. This is kind of important. That's 25% operating margins. Over the last 10 years, their average operating margin has been 32%. Over the last six years, roughly, so from 2016 to 2022, it's been 35%. So this is a significant

decrease, lots of margin compression here. Worth kind of monitoring that. if we get some sort of a, I guess, rebound in margins, it's going to make the multiple look a lot cheaper than it is today. The other thing I'll add is they've seen a big increase in inventory over the last two years. Now, part of that is when you have inflation, the cost of that inventory is higher. So that's part of it, but also they've just been adding more and more to basically be able to fulfill their different channels. And so that's been kind of a big discrepancy between the cashflow numbers and their operating income figures. On top of it, accounts receivable has gone up as well. So those two big changes to working capital has really kind

of hurt cashflow in the short term, but I suspect that cashflow will continue to be generally quite close to operating income. Brett, you want to add something? Yeah. So just clarify, because you froze a little bit on the margin. It was 36% recently. And then over like a 12-year period, it was 32%. I just want to say that one again. Yeah. Sorry. I didn't notice that I froze there. So last 10 years, 32% is the average. That includes this year. From 2016 to 2022 though, so basically prior to COVID and all these big cost increases, it was 35%. And then last year is 25%. So, if you're looking at this on a trailing operating income basis, it's going to look very depressed relative to the last decade. But operating cash flow, like I said, it generally

tends to trend close to operating income. However, there was a big 23% decrease this year due to that increase in inventory and accounts receivable. I'll have all the chart in the letter as the conversion from operating income to cashflow. So people can kind of look at that and see how it's slightly lower consistently. And then CapEx is usually pretty light. It was elevated this last year, but it's typically just under 10% of operating cashflow if you look at it over the kind of, I think, last 20 years. But I wanted to hit on some of the long-term numbers because I think for a business like this, looking at the long-term averages is really important because you can get fluctuations in any given year. But since 2012, Monster Energy

case sales, so volume of cans essentially, has grown at 12% a year. Average net sales per case has actually decreased by 1% a year. So you can call that basically price. Interestingly enough, I think when most people think, has Monster increased prices? You'd probably say yes, and they have, Monster has, but because of the geographic and product mix, so expanding internationally and having some of the lower cost cans, so like Rain, do well, they've had sort of a decrease in that average price per case because basically they don't have as good of market share as they do in the US. So they kind of have to be at lower cost in a lot of these markets. And so that's had a big effect on their average sales per case. And then,

Like I said, operating margin has been around 30% since 2005, and it's been lumpy, but it's trended upwards. And shares outstanding have come in by about 14% since 2016. So they tend to buy back around 1% to 2% of their shares each year, and it's been pretty steady. So those are some long-term- It did go up. Yeah, it did go up during the Coca-Cola deal, though.

That's kind of right after the Coca-Cola deal. So when you look at the shares outstanding chart, they did that deal, probably value creative, but it'll mess up that pretty looking shares outstanding chart. And hopefully over the next 10 years, they can keep it steadily declined at 1% to 2% a year. I will note though, I did share that chart for the video watchers. The cases one is one of the key KPIs you can look at on Stratosphere. So check out that visualization. You can easily that that's the type of stuff that they're aggregating for us and we don't have to chart ourselves. So just check them out stratosphere.io. So, all right, Ryan, you have balance sheet now or anything else on margins?

Well, I'd just say, I mean, you look at the earnings over the last decade, it's been really steady and really impressive. Balance sheet, it's really straightforward. They've got $2.7 billion in cash and short-term investments. Most of that is in short-term investments, but they keep about a billion dollars in cash. No debt, not a single lick of debt. I mentioned that inventories have gone up, accounts are simple, have gone up. So, that kind of hurt cashflow.

But yeah, not a lot of liabilities here. They will be receiving some cash this year from their settlement with Bang Energy. So they basically sued them over improper branding. I don't have the specifics of the arbitration, but they're going to receive- Yeah, look that up if you're in. Yeah, we're not going to hit on this show, but yeah. I think it was around like $300 million in cash. So you can maybe just add that to the balance sheet. I think there's also like a royalty deal that's involved there as well. But historically, they've used their cash to either buy other companies like Canarchy or invest into new products or buy back their stock. That's about it. Those are really the only things they do with their cash. Yep. The big highlight there for me was that it's nice and clean and consistent, which is something we look for, for companies that will specific, you know, you might look for more opportunistic stuff within capital allocation businesses or conglomerates and stuff like that. But for operating companies, we like to look for that consistent use of cash. I'll hit valuation, super quick. Market cap right now, 54.9 billion. Enterprise value is going to be slightly lower at about 53.6. I have, although I believe my debt number might be a little off. No big deal though. And I'm only going to use one number here. And that is enterprise value to operating income. I think operating income or EBIT or earnings before taxes is the

best metric to look at here. The cashflow can get a little bit muddy from time to time, but typically the cash will come back to the company. Right now, given the depressed margins, they are trading at a very high multiple of 33.8 by my count as of this recording. I would just, if you think their margins are going to come back, just take that earnings number or take that revenue number, slap a 35% margin or slap a 32% margin on it and look at what the earnings would be and what the multiple would be there. It would be probably in the high 20s. I didn't write it down, but still a premium multiple for sure. The market is pricing in quite a bit of future growth here.

And that's all I'll say. Let's move to anecdotal evidence. Ryan, what do you think? Yeah, I don't personally drink that much energy drinks. I'm kind of a coffee guy. I used to. I had less of probably like brand loyalty compared to other people. But the friends that I know that drink energy drinks are pretty brand loyal.

And I would say Monster is probably the dominant one. People that drink Monster continue to drink Monster. It's very addictive, high brand loyalty. People aren't going to bat an eye about a $3.25 price versus $3.50 price, at least here in the US. And they basically said that in the last earnings call. They raised prices by 6% this year in the US, saw little to no attrition so um yeah i think it's a wonderful product and a really durable business yeah not wonderful for you a wonderful product for shareholders it might be quite unhealthy those sugar ones but they are actually moving into sugar-free which i thought they could have been a little bit late to the game on that sugar-free stuff i don't know why they haven't

done that for the last decade but hey that could be you know it could be another growth opportunity because I know Red Bull has been big on the sugar-free stuff and these health drinks, or I wouldn't call them health drinks, but the energy drinks that we'll talk about later that are focused on branding themselves as health or health-focused, like Celsius and Desolator, but there's other ones. Maybe this is a way to counteract them.

They've talked about that as well. But yeah, it's very similar to soda. People don't have, I wouldn't say, it's not intense brand loyalty, like with maybe a musician or even it's not as strong as Apple or Disney where people kind of get intense about it and argue about it with friends. But it's sort of like the soda in my mind where, all right, you'll use it and you're going to do the same one because it tastes good, it's reliable. And you know that if you change, you have risk of, okay, this one's bad for that

one time. I'm just going to have the same one every day. It honestly reminds me a lot of the nicotine market maybe not as much like brand loyalty to the to the big brands like marlboro but you think like with kind of the up-and-comers sort of uh with the health focus products i think they're kind of similar to the reduced risk products and nicotine and then you still have like the stalwarts um with in this case maybe monster could be similar to the marlboro except you actually know i'd say red bull i'd say red bull because red bull is the most premium focused maybe wouldn't you say yeah yeah i guess um except i can't think of is there is there any other second cigarette maker that's like yeah i guess it's almost like there's two yeah it's

almost like there's two yeah two in the u.s because they both have 40 market share but and and unlike nicotine you actually have a uh an industry that's growing yeah that's fair point And soda. Soda, I guess, in some markets is growing, but in the U.S., I believe volumes have stalled out. Although, don't quote me on that. I think the only other question I have for Andy Joel Evidence is, is the energy drink market, or has it ended up like Coke and Pepsi with Monster and Red Bull? I'm curious your thoughts. i think it is likely but i'm not 100 convinced on the durability compared to the not the coca-cola

market but the the the cola soda market of coke and pepsi having absolutely zero competition i think it is i think it's similar i think it would be more if i'm if i make an analogy i'd say it's like probably more like nicotine if there were two marlboros but the coke and pepsi is a good analogy um i wonder if there's more pressure from kind of society regulators to uh try to limit energy drink kind of limit the energy drink market i know obviously there's of stuff with kids yeah it seems to have passed it seems to have passed now but i don't really understand it because a lot of the other stuff has a lot of their products that people consume have a lot of caffeine right it feels like it has more stigma more of a stigma than the soda market

yeah i mean coca-cola generally i i don't want this is total conspiracy but i i i'm 100 that's that's some advertising warfare from the soda makers or any of the other drink makers or the coffee industry, 100%. They tried to warp everyone's brains into thinking that the energy drinks were evil compared to them when they're very similar. Obviously, both are not healthy. But let's move to future growth opportunities. Ryan, what do you have for us here? Because the big one is just betting on the growth of the energy market. We don't necessarily need to focus on that one, but what have we got outside of that? Yeah. I mean, the obvious growth is more the same, basically what they've been doing over the past two decades, but something that's kind

of a potential unexpected growth driver, I'd say, is the entrance into the alcoholic beverage category. I know we both kind of have similar future growth opportunities here, so maybe we can parlay some of these questions that we have for each other into one conversation. but they paid $330 million for Canarchy. And I think that was really just a way for them to get sort of, maybe they did the math themselves and said it would be less costly for us to acquire our way in than to try to build out the distribution network ourselves. So there's a quote here from their presentation when they announced the deal. It says, the company, Canarchy, and this is really important, already operates with the People Distribution Network

licenses, alcohol, beverage, development expertise, manufacturing capability, and infrastructure necessary to grow our alcohol business. They've been sort of experimenting or tinkering with some of Canarchy's brands, namely the Seltzer and the Pale Dale Ales. Is that what it's called? no clue they're not yeah they're neat yeah they're niche geography ones right now so dale's pale ale that's what it is um anyway they've been tinkering with those but then they've also launched their own alcoholic beverage uh which is called the beast unleashed it's a six percent uh six percent alcohol content seltzer and uh they've launched it in six states now and they're planning to have it rolled out nationally by the end of the year.

Two-part question, and I think we can both answer this. First of all, would we try this? And do you think alcohol or the alcohol category can actually truly help drive sales for Monster? Yeah, and just for listeners, these are not four locos. They don't have caffeine and they don't have sugar. So they're pretty much like a hard seltzer because I believe caffeine plus alcohol solo drinks are banned now, although a bunch of drink people still combine those things and make their own. So just just to be clear, I think I would try this, but it wouldn't be my first choice for a drink. I don't know.

Yeah, I think I try it experimentally. Yeah, I definitely try it. I don't like the energy drink taste too much. I will buy... If I'm on a road trip, I will go to a Red Bull if I'm super tired and I need to not fall asleep. That's the only time I'd really go for something like that. But I could see for the people that like that taste of the monster flavor, which it seems to be that people get habitually like that taste. And regardless of whether people think it tastes bad, remember that a lot of the best-selling products in the United States and the world have,

quote-unquote bad flavors. Hershey. Coca-Cola is kind of gross the first time you try it. Mountain Dew is absolutely disgusting. It doesn't really matter. And I kind of feel bad. Red Bull is disgusting. Red Bull, Monster, I almost copied that really and just slapped on some adjacent branding or, excuse me, not adjacent to conflicting branding to counter position themselves. I think, yeah, people would try this. There's definitely potential here, but it's a bit uncertain so i think it can drive some growth if they you really the thing is you really only need one one winner because you get one sort of brand winner within a new space think about the hard

category yet truly yet you know that that one is a little bit um dynamic but you only really need one winner that can kind of drive growth and yeah they gotta it's got to be a big winner given the size of this business but i i think they could what are your thoughts you pessimistic or optimistic about their alcohol venture well i think if someone sees monster and six percent alcohol i think the first instinct is going to be that this is for loco 2.0 uh which people like because it's as long as it doesn't you know it won't kill people if it doesn't have caffeine but you know people like that they would like that for sure especially a lot of the common monster drinkers that are above the age of 21 here in the us would would probably try this i don't know if

it'd be like i mean it depends on taste whether or not they'll be it'll be a staple of their alcoholic beverage appetite but yeah and you could definitely see people it's weird it's a weird dynamic because bars are able to sell a huge thing for the distribution for these energy drink companies and how they started out was getting into bars and having the non-alcoholic drinks getting used behind the counter to make these mixed drinks. And it's so weird that people are going to make them with these caffeinated stuff. But yeah. The only other thing I'd add here is that the benefit of getting out of the... And I'll bring up a chart of getting out of the just energy drink or just the standard energy drink brand is that right now they are at 90%

exposure or 90% plus of their business is still within the monster beverage or the energy drink category, right, Ryan? And that's not even their strategic brands, which might have some stuff that is still... And if we look here, it's just all of the growth in the shared chart here is from the monster energy drink case sales compared to the strategic brand sales. If they can succeed in this category, it'll give them that diversification like the big cpg giants or get them on their way to being like a pepsi a coke a hershey a unilever and that really allows for just more diversification where you're not just betting okay is monster going to stick around for 10 years because that's a bit riskier because you

never know what's going to happen with one brand yeah i think a bit of a hedge i guess yeah and it just i don't know if it makes it a better business but it makes it the diversification i think helps but let's move to highlights and all that's ryan what do you like dislike about this business yeah the highlights are pretty simple for me they're strong brand loyalty it's literally an addictive product and i think they have solid pricing power um especially domestically the other part the global distribution network thanks to coke from a standing start i think that'd be hard to replicate without going through one of the big players, it is worth noting that Celsius basically did a similar deal recently with Pepsi.

Very smart. Very smart. So there is the way you could potentially do that. And it's not an advantage over Red Bull because Red Bull has sort of that same distribution, but it's definitely difficult to do if you're like an up and coming energy drink maker. I like the simple capital allocation strategy. And then I also think having some Coca-Cola members on your board maybe gives you a little bit of expertise, a little bit of useful advice for someone that is a company that has great relationships with retailers. Lowlights for me though, I think they could have been a little more aggressive with their balance sheet throughout 2020 and 2021. They easily could have

got an extremely low cost debt. Now, obviously that's hindsight and rates have risen, but I'm being nitpicky. It just feels like, you know, they just sat on cash and treasuries. Yeah. They could have easily gotten spread out over multiple years, $5 billion worth of bonds at 10 plus years at 3% interest rates. So yeah. Probably less. Could have been, yeah. Depends on what year, but yeah. If they really timed it perfectly, they could have gotten it less,

but I guess you can't just be super nitpicky on that. But did you have any other low bites? Yeah, I would just say, I think it's going to be harder to grow volumes over the next 10 years than the last 10 because I just think growth is less likely to come from growth and distribution because they're already pretty saturated

or they have, I shouldn't say they're saturated. They have distribution points all over the globe. So especially with a monster brand, it's not like they can kind of just – they're not entering these markets for the first time. They can kind of maybe drive success with some of these lower cost products like Rain and stuff like that, NOS. But basically, I think they're either going to grow volumes at a slightly slower clip, or they're going to have to make up for some of that revenue growth with price increases, which I think they're able to do, but I just don't expect volumes to grow as fast as they did over the last decade. Yeah. And even if they don't put in insane price increases or just execute phenomenally in

some of these emerging markets, as maybe we'll just call them on this episode, they can still revenue at, say, 10%, but that is a big slowdown to historically. It's been at around a 15% to 20% clip. I kind of agree with you there. My highlights, I think they've finally crossed the chasm. I don't know if it's... I always confuse it. Where is it? Chasm or chasm? I think it's chasm, where they built up the brand recognition over the years. And I believe, at least in certain markets, have elevated themselves to the status of Coca-Cola, Pepsi, Gatorade, Red Bull, Tropicana, and other CPG drink names days. I think this is extremely hard to do. It makes it much more difficult for someone to disrupt them, at least quickly.

And what I also like is that they are the type of company where I'd almost talk... Their marketing strategy seems to be a combination. And this is Red Bull as well. And I really copied Red Bull, but did it for their own demographics. It's a combination of the Coca-Cola marketing strategy of just habitual, you know, hey, have this every day. You'll be happy. It'll help you.

And the Nike strategy where you attach yourself to a lot of athletes. I know they're in the extreme sports. I mean, their biggest athlete is Lewis Hamilton, which is funny because they sponsored the team that is rival to Red Bull. So it's kind of fun in that regard. And then a few of the other ones

where they're basically selling, okay, if you want to be like these athletes, if you want to be like these, even these military people, which I guess is they don't do as explicitly, you're going to drink Monster. I think that's really smart. And I can, I don't know how,

it would be very difficult for someone to disrupt them within that marketing strategy. I guess we'll talk about it. My lowlights is the health focused ones. Other one, consistent repurchaser of shares like that already mentioned it. I think the Coca-Cola partnership was a very good masterstroke in defending their position in the marketplace. And then I think

the leadership team generally has long... Or I don't think. The leadership team generally has long tenures, and they speak frankly, rationally, and conservatively to shareholders. I love that about them. Lowlights. First one, we already talked about them being a bit greedy with the corporate expenses and self-dealing. They'll outline that above. I think the other one that I would like to discuss is the market share gainers within the energy drink category. We've had Celsius growing quickly lately. Before that, it was Bang Energy. Before that, it was, well, Rockstar is, I guess, just as old, but Rockstar was a big competitor, I guess, back in the day. There was 5-Hour Energy and others that I'm missing. None of them have shown

the ability to meaningfully edge away Red Bull or Monster's market share yet, but I don't think it means they won't. And I'm curious your thoughts on the shift towards the quote unquote healthy energy drinks becoming more popular because Monster has some products going into this space, but it seems like Celsius has caught quite a bit of fire by going to the gym people, trying to go with those type of Instagram influencers and stuff like that and having that sort of niche. And I kind of think they could maybe get 10% to 15% of the market, but I don't know whether that sort of niche can become a 40% market share in energy drinks. What are your thoughts? I think it's also expanding the market. Yeah, to women. It used to be not all, but most

of the guys and Celsius is big among women. Yeah. I mean, you're seeing that the category as a whole is growing. Monster is growing, even though their share might not be. So I'd say it's not necessarily cannibalize. Even if some of these more health-focused products grow, it's not necessarily going to cannibalize Monster's business. But let's talk bull case and bear case unless you have anything else. Nothing else. Okay. For the bull case, I just put some kind of five-year assumptions together. And I think these are very reasonable assumptions. And basically, let's see where we get with these numbers. So let's assume they grow total sales by 12% annually. Their last 10-year average has

been 12.2%. That's kind of in the average annual growth. Operating margins get back to their last 10-year average, which is 32%. And keep in mind, prior to COVID, it was at 35%. So if they can get to around 32%. I don't think that's too unreasonable. If those two things happen, by 2027, they would be generating about $11 billion in revenue and $3.6 billion in operating income. Their average enterprise value to operate income has been 25 times over the last 10 years. So let's say it's the same. You'd have a $90 billion enterprise value. Today, it's about $52, 53 billion. So 73% return over five years plus some buybacks. That's a good return if they get back to sort of their average numbers over the last 10 years. And if they get to 35% operating

margins instead, which is basically to say like kind of, I think what they were at prior to the recent cost increases and who knows if the cost increases stick around, it's even better return. it's probably a double or more over the next five years. Yeah. And remember, any listeners, because we will talk about the bear case, the multiple needs to stay at a fairly high rate there. I'll talk about mine. It's fairly similar. We're at 34 times as of this writing EV to operating income. I think you need margins to expand higher into that 35% plus range and see 10% revenue growth for the next five to seven years, or you got the 12%, maybe 12% revenue growth plus the multiple stays high. And I think

they can do that with retaining the market share within core Monster Energy, just do what they've been doing, and expanding its international markets, and then having success with the alcohol category. And I'll add one on here is having success with the sugar-free and maybe the health-focused stuff that they're trying to expand into within the Monster Energy category to defend their position versus these early upstart market share gainers, I think you'll probably do fine, as Ryan mentioned. But let's move to the bear case. Hard because it seems like such a good business. Brian, what do you think? Well, obviously, multiple compression is a big one. And it probably will come in because I think they're under-earning right now.

So, well, margins are expected to tick up, I should say. So, it'll probably come in. I think that's kind of the market saying that they expect that. But then the other one is if operating margins over the next five years are closer to 30% instead of 35%, so those cost increases are maybe here to stay, then that's going to really hurt returns. Also, like I said earlier, I think they have to be more creative to grow revenue from here. It can't just be pure volume increases thanks to the distribution. It's got to be success with the sugar-free category, success potentially with the alcohol category or price increases. I think all those are doable. I think they can still grow at a really strong rate, but I just don't think it's

all going to come from volume like it mostly has over the last 10 years. Basically, I'd say if costs stay high or the multiple compresses more than people already expect you've probably got it's it's still going to be a decent investment i think it's very predictable that this business is going to grow but it's not going to be a double-digit return it's not going to be last decades returns over the next 10 years yeah well in that scenario in that scenario in that scenario that scenario yeah and but over the last 10 years i believe it's up like 500 i would really and it would become a huge business if it was up 500 but correct me listeners don't call me on that i think it's a 500 in the last 10 years but totally cannot be yeah i mean mine look i think this is a really

high quality business i think it's a combination of mostly you know coca-cola plus sprinkling a a little bit of the tobacco companies with that market that people don't, politicians love to hate and the caffeine stuff where it's addictive even more so than a soda. And then sprinkle in a little bit of Nike marketing as well. And I really love that. So the only bear case I have is multiple compression. Even if earnings grow at 10% a year for five years, but the terminal multiple here in year five is 15 times to 20 times operating income. I don't think investors are going to be happy with the returns yeah that's really it simple math addictions tend to be good businesses yeah but you know good investments yeah good yeah yes not good personally although i don't know how

bad martin energy really is obviously it's not healthy but it's not you know it's not killing the people i don't think but yeah it seems like the market has already established this that the company is super good, sort of like a lot of the other top-notch CPG brands out there. So are you more or less interested here, Ryan? I am more interested than before we basically did this not-so-deep dive,

but it would really take a lot, I think, for me to say, like, I'm going to buy this. I just think the expected returns from here are not going to be what they once were, And it's also, I mean, it is very predictable, durable, but it's such a premium and the good CPG businesses get those premiums, but in order for you to get a good return, you have to expect that that premium sticks around because if there's any multiple compression, it's really

going to hamper your returns. Yes. I totally agree at 34 times. I do not really. Yeah. It's just not, I don't, it's not appealing to me. This we're trading at like 20 to 25 times. And, and I thought margins were going to expand. I do think margins are going to expand. It would be way more attractive to me, but obviously, you know, it's not. And that is to say that the market is the market knows how good of a business this is. Yeah. I would be all over this at 15 times earnings and i wanted to pull up on stratosphere it's historical pe ratios i wanted to look at the gfc we're at about 16 times in 09 17 times 20 times oh five i guess they maybe had a little collapse after the initial bump of the monster brand we had about 14 but historically since

this bull market is wrong we've kind of been at and i know pe isn't perfect so maybe it's not the same we were kind of at the 20s so i don't know if i'm expecting it to ever fall below 20 times but if it is i'd be really interested in doing some work on it or some some more work i mean at 15 times i think it's a great buy but i don't know if it's ever going to fall to that ever you know since the coke deal since the coke deal it hasn't fallen below 25 times yeah and we'll see we'll see never say never uh but yeah all right that's gonna do for this episode remember subscribe to the newsletter and get the analysis along with each episode we are covering cpg this month next week is phil morris international after that's pepsi then

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