CELH: KO 1989 Again? Ask Pepsi

Largest market share in the fastest growth niche (sugar-free) of the highest growth beverage category (energy drinks)

JPM initiates CELH with Overweight rating (update): The analyst suggests that Celsius’ current 10% share of the U.S. market could see a 10-29% increase in equity value, assuming Monster’s U.S. market share drives 60-70% of its valuation. This estimate, however, doesn’t account for further market share growth, international expansion, entry into new categories, or margin improvements, Teixeira adds.

Pepsi effectively acquired 8.5% of CELH in 2022 (source: CNBC)

The resemblance between CELH today and KO when Buffett first bought it in 1989 is uncanny. It’s like someone bottled KO into a time machine and sent it into the future:

• Both are/were suffering from clearly temporary growth setbacks;

• Both occupy top positions in their respective branded retail sectors (i.e. pricing power);

• Both are/were gushing FCF despite prevailing sentiment about future growth;

• Both are/were mainly US businesses with clearly untapped International potential — which markets were severely underestimating;

• Both had plenty of room to increase financial leverage, with ridiculous ROICs;

• (Note: I made a slight error here earlier about KO’s valuation in 1989, which has since been edited out. Fortunately it doesn't really change anything, the point that I was trying to make was that the trailing PE reflects trough demand conditions.)

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Margin Accretion via Solving Supply Chain Incentives

Celsius’s extremely successful strategic partnership with Pepsi in 2022 has since become a model for the rest of the beverage industry to follow. This mutually beneficial partnership came after Bang Energy’s catastrophic implosion, which released Pepsi from its exclusive relationship with them and allowed it to court Celsius. Hence there exists a beaten path for Celsius to maintain its current No. 3 position in the energy drink market — simply follow what came before, and avoid Bang’s mistakes of overleverage and hypergrowth.

Achieving success in the beverage industry is fundamentally a matter of resolving incentives across the value chain. Each stage of the supply chain has various parties with their own incentives — from the manufacturer to the end-customer — where solving them amounts to incremental margins for the brand owner. From this perspective, CELH 0.00%↑ possesses an entrenched position by virtue of its ability to provide lasting solutions to each stakeholder within the beverage industry’s value chain.

There are a few key bottlenecks within the beverage industry’s supply chain which represent its fulcrums for incremental margins. Pepsi’s $550M investment in 2022 almost certainly involved Celsius switching distribution modes from DTR¹ (direct-to-retail) to in-house DSD² (direct store delivery) using Pepsi’s blue trucks (ala Gatorade). This not only reduces outbound freight costs but also increase sales velocity — simply by reducing out-of-stock situations at end-retailers. DTR relies too heavily on reliable restocking by minimum-wage store employees with little incentive to do so — as compared to Pepsi’s distributors, who are penalized on underperformance. This matters when >50% of Celsius’s sales occur through the convenience store channel, which has the highest margins vs. grocery or e-commerce.

Pepsi’s incredible distribution reach also no doubt helped Celsius in getting placement alongside Red Bull and Monster in checkout coolers and within cool doors at mass retailers like Walmart, which significantly increases the incidence of impulse purchases. This is a huge improvement over Celsius being stocked at the soda aisle when Anheuser-Busch was still their distributor (prior to Pepsi) — much less when they were still placed at the health foods aisle next to vitamins before that. Celsius rapid +100% sequential sales growth to the No. 3 spot until early this year was also no doubt partly due to Pepsi treating Celsius as a priority— ABInBev would prioritize trucking beer to stores first, whereas soda is a priority for Pepsi’s trucks.

This premium placement spins the sales flywheel as convenience stores and mass retailers alike are incentivized to prioritize shelf space for brands with the highest turnover and restocking capacity³. Celsius’s nationwide reach of 98% ACV⁴ puts them in the same ranks as Red Bull and Monster in the energy drink space — all but placing a distribution moat between them and smaller brands like Alani Nu or Ghost.

Celsius’s being in the ‘better-for-you’ category (i.e. sugar-free) also solves highly differentiated consumer incentives as compared to Red Bull and Monster. The typical energy drink consumer is a blue-collar male, and would be hard-pressed to find similarities between the harsh chemical flavors of Red Bull vs. the green tea and ginger base of Celsius’s drinks. The latter’s sugar-free options appeal to an entirely different target audience consisting largely of women and professionals.

Such bifurcation of consumer segments creates new markets for the energy drink sector, as Celsius’s growth comes from growing the pie rather than stealing market share from existing players. This is not unlike how Uber introduced ‘ride-sharing’ rather than fighting for scarce medallions; or how LCCs opened new routes at airports located in the outskirts rather than compete with incumbent FSCs at main hubs. Management commentary in their Q3 earnings call also alluded to this being one of their main growth drivers:

John Fieldly President, CEO & Chairman

The sell-through data we are seeing continues to be supportive of us being the largest driver of the energy category. I want to reiterate our 3 key growth drivers that we are focused on for the rest of the year and beyond: attracting new consumers into the energy category; expanding the product availability; and increasing consumption frequency.

source: Nielsen, Fairtree

As the highest-growth niche in what is already the highest growth beverage category (energy drinks), sugar-free represents a vastly trending segment of the beverage sector. Celsius’s 9% market share stands heads-and-shoulders above Alani Nu’s 2.4%, Ghost’s 2.6% and Reign’s 2.6%. This is before considering their nearly 12% dollar share in MULO+ Convenience⁵, the highest margin category. KDP’s 60% acquisition of Ghost for $1B last month and Monster’s recent investments in sugar-free innovation represents seismic shifts in the sugar-free segment — the following commentary is from Celsius’s Q3 earnings call:

John Fieldly President, CEO & Chairman

All right, Eric. Excellent, Eric. That's the first question in regards around the execution and really as you further identified the sugar-free movement that's taking place in the energy category with Red Bull now further leaning in as well as Monster leaning in with some innovation in sugar-free.

This just reinforces the opportunity that we have at Celsius as a strong, solid #3 player in the energy category. This shows the opportunities we have to further work with our retailers and bring more consumers in as this category not only grow, it gets back in a growth mode, but further seize the sugarfree energy movement and percentage of business continue to grow at an increasing rate.

Celsius’s growth is also a function of solving incentives with market incumbents, namely Pepsi. Building a new brand from scratch is an expensive affair fraught with uncertainties, even for incumbents — with market leaders in various consumer sectors preferring to acquire existing successful brands and take them to the next level instead. KO’s 16.7% stake in Monster and KDP’s recent 60% acquisition of Ghost belies such incentives, with the exclusivity arrangements effectively serving as a moat between them and smaller brands outside the walled garden. Alani Nu’s inability to find an acquirer since mid-2023 demonstrates the difficult of crossing this moat; Celsius has found itself on the other side before too, prior to Bang’s implosion in 2021 which disallowed Pepsi from courting them.

In their recent 3Q earnings call, Celsius management guided that much of 2025’s expected sales tailwinds would come from a recent update to its incentive program with Pepsi, which includes an additional focus on priority periods — e.g. holiday seasons, back-to-school, end-of-year clearance sales, etc:

Kaumil S. Gajrawala Jefferies LLC, Research Division:

I guess, a couple of things. The first is you're specific to mention in your prepared remarks that the new incentive structure with Pepsi and that you're positive about it. Can you give us maybe some more details on what's behind that and why that should drive category acceleration from where we are now?

John Fieldly President, CEO & Chairman:

Yes. When you look at it, the program -- the further alignment and incentive program we implemented in 2004 is really further getting implemented into 2025 with additional focus on priority periods. We just finished NACS last month and coming off their annual operating plan meeting that was in Las Vegas that our group -- our leadership team as well as a variety of other team members attended.

Just -- we're getting great cross-functional collaboration, further alignment on our 2025 plans. And it's -- we feel like we're going to have more of a cohesive approach as we're further aligned to truly drive this category, getting additional availability, expanding placements and getting Celsius in the hands of more consumers and disrupting that path to purchase, which is so critical on building a brand and getting more trial.

This follows an earlier amendment to their incentive alignment program with Pepsi in March, the details of which can be found in their notes:

On March 23, 2024, the Company entered into Amendment No. 1 to the Distribution Agreement with Pepsi, pursuant to which the Company will provide Pepsi with an incentive program designed to incentivize and compensate Pepsi for its continued focus on and actions to support the Company. These incentives are accounted for as promotional allowances and recorded as a reduction to revenue.

The sum of all this is to say that solving incentives across the value chain is a reliable lever for margin accretion that buffers Celsius’s moats against competition, both big and small. Their sugar-free branding differentiation solves different consumer incentives vs. incumbents Red Bull and Monster — which as we saw in last week’s article about Brands, is fundamentally a matter of self-expression. This means that Celsius’s further success is a beaten path with formulaic levers that benefits from defensive moats against incumbents, which calls into question the peak-to-trough 75% crash in their share price, that just inflected last week.

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Why CELH crashed 75%

Celsius has had eye-popping +100% sequential revenue growth since the pandemic started until recently (source: TIKR)

After several successive periods of +100% sequential revenue growth, CELH came crashing down to earth when it guided slower sales growth in Q1, owing to the temporary Pepsi overstocking situation which management expects to be resolved by year-end. This impacted YTD earnings and resulted in CELH’s artificially high trailing PE of 40x.