Monster Beverage Stock: Overpriced In The Current Environment (NASDAQ:MNST)

Monster Beverages’ (NASDAQ:MNST) stock price has fallen by slightly more than 1% year to date, compared to the ~18% decline of the broader market.

On one hand, we could expect Monster Beverages and other firms in the consumer staples sector to continue outperforming, due to their relative safety during times of low consumer confidence and market volatility. On the other hand, we have to understand whether the valuation of the firm is currently justified, and how increased raw material prices and freight costs are expected to develop in the near term.

First we will take a brief look at the firm’s first quarter financial results, focusing primarily on demand and costs. Then, we will look at commodity prices, along with the U.S. consumer confidence, using it as a leading economic indicator, to try gauging, how consumer spending may change in the near future. Finally, we will briefly discuss, whether the current valuation is justified in our view or not.

First quarter financial results

In the first quarter of 2022, MNST has achieved record sales of $1.52 billion. The primary drivers of this growth were the Monster Energy® Drinks segment and the Company’s Strategic Brands segment, both growing by double-digit figures, compared to the year ago quarter. The other segment, which includes certain products of American Fruits and Flavors, LLC has also exhibit growth, but less significant.

Despite the strong sales figures, Monster’s gross margin has been hit hard. The firm’s gross margin has declined by as much as 6% compared to the same period last year. The key drivers fuelling the margin contraction were:

1. Increasing fuel and freight costs.

2. Increasing packaging costs, both primary and secondary. High aluminium can costs were a result of high aluminium commodity prices.

3. Production inefficiencies and sales mix.

Although the negative impact of these factors has been slightly offset by the pricing of the products, the margin contraction is still significant.

We believe that Monster is a well-recognized brand worldwide with a loyal customer base, therefore in our opinion the firm may be able to continue partially offsetting the elevated freight and raw material costs by increasing prices.

On the other hand, we expect the commodity prices, especially oil prices, to remain elevated in the near term, potentially further hurting MNST’s margins.

Let us take a look at the development of some of the commodity prices crucial for Monster’s business.

Commodity prices

Gasoline prices

The price of gasoline has been on the rise since the second half of 2020, but it skyrocketed in the beginning of 2022 as the geopolitical tension in the Eastern European region started to unfold.

These high gasoline prices are one of the main factors leading to MNST’s gross margin contraction.

Despite some of the good news earlier this year, regarding the higher than expected increase of oil output in the second half of 2022 by OPEC+, the oil and gasoline prices have not come down substantially.

On the other hand, Russia has significantly reduced its gas supplies to Europe in the recent weeks, which combined with the incident in the Freeport LNG plant in the U.S. has made Europe’s energy security in the near term even more uncertain.

Due to this uncertainty, we believe that oil and gasoline prices are not likely to significantly drop in the near term, resulting in elevated freight costs for MNST in the rest of the year.

Aluminium prices

The price of aluminium has reached its peak in early March and has already come down substantially since then.

The price drop was caused by declining demand and increasing production.

Although the price of aluminium remains elevated compared to pre-pandemic levels, we believe that it has already peaked and likely to continue declining in the near term.

For these reasons, we believe that the firm’s margins may slightly improve compared to the first quarter.

Consumer confidence

Consumer confidence is often regarded as a leading economic indicator, which could give a picture about potential changes in consumer spending in the near future.

In the last couple of months, consumer confidence in the U.S. has been declining steadily. We believe that this could be an indication that the spending behaviour of the American consumer is likely to change in the near future. This change could entail reduced spending on durable, non-essential, discretionary items, however spending on consumer staples should be less impacted. A potential impact in the consumer staples sector could be the shift to lower cost alternatives, which could lead to less demand for Monster’s products. But, as mentioned previously, we believe that MNST has a loyal customer base, a significant brand recognition and diverse product portfolio, which puts the firm in a strong position to weather the storm.

In short, we do not expect MNST to be significantly hurt by low consumer confidence.

Just for comparison, the following graph compares Monster’s performance between 2007-2010, with the S&P 500 (SPY). This time period was characterised by low consumer confidence, and MNST substantially outperformed the broader market, by gaining 14%, compared to the 21% decline of the SPY.

Valuation

On one hand, MNST seems to be an ideal pick for the current macroeconomic environment (despite the contracting margins), on the other hand it appears to be trading at a significant premium compared to its peers.

When looking at some of the traditional price multiples, the firm seems to be overvalued.

In terms of price-to-earnings ratio, MNST is trading at 35x, compared to the 18x of the sector median of the consumer staples sector. EV/EBITDA and P/CF are also indicating significant overvaluation.

While we appreciate MNST’s rapid growth, both organic and inorganic, its commitment to return value to its shareholders through share repurchase programs and its substantial amount of cash on hand and minimal debt, we believe that the current valuation is not justified.

Key takeaways

Strong financial results in the first quarter, driven by record sales. However, margin contraction, caused by the elevated commodity prices and freight costs, has slightly overshadowed these results.

Monster has significantly outperformed the broader market in 2007-2010, when consumer confidence was as low as now, therefore, combined with the strong financial performance, we believe that MNST could be a great place to hide in the current market volatility.

On the other hand, the firm appears to be trading at a significant premium, therefore we do not recommend starting a new position right now.