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Will This Energy Drink Maker Peter Out?

What's behind our bearish call on Hansen Natural, maker of the Monster energy drink.


Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, co-editor of Morningstar OptionInvestor. Today it's my great pleasure to welcome Phil Gorham, who's a drinks analyst here at Morningstar. Phil, thanks for coming.

Phil Gorham: Thanks for having me, Erik.

Kobayashi-Solomon: A couple days ago I wrote this article about a company named Hansen Natural that you cover. It takes a bearish view on Hansen. And I really didn't know Hansen until I saw the logo of its main product, Monster Energy Drinks.

Gorham: Right.

Kobayashi-Solomon: So I just wanted to ask for a little bit more color on Hansen and Monster Energy Drinks. I think within the last 18 months they signed a couple big distribution agreements, and I just wonder, is this the kind of thing that they can repeat? I mean, that really boosted their revenues. Can they repeat this? Is this a one-off? What's your view on their revenue situation going forward?

Gorham: Yeah, it's certainly a one-time pop in North America. What they've done over the last 12 months or so, is that they've moved their off-premise distribution from Anheuser-Busch to Coca-Cola Enterprise, which is the primary distributor of Coke products in North America. And that's certainly providing a short-term boost to revenues, because that gets them into more stores, more convenience stores, more grocery stores across the North American continent. And that's providing a boost.

Kobayashi-Solomon: And do you think that boost is about over now? In other words, have we seen kind of the main impact of that?

Gorham: Right. Well, Hansen laps cycles that distribution agreement in the first half of this year. So absent any further agreement I would certainly expect to see, towards the end of the year, the double-digit growth rates that we've seen in the past slow down somewhat.

Kobayashi-Solomon: All right, so kind of second half of 2010 we should see it slowing down. And that will make comparables even harder for them at that point.

Gorham: Exactly. Unless, of course, the company can find another distributor in an international market or even somebody else in North America. I think that would be unlikely, but international markets are an option.

Kobayashi-Solomon: Still may have some growth. I see. Now, like I said, this is a bearish position and I'm usually pretty cautious about taking bearish positions in consumables companies. Right? I mean, consumables are generally something that people need no matter how the economy is doing.

Talking with you about this company, though, I see that maybe Hansen is not your typical consumables company in that it might have some effect from an economic slowdown. What's your view on that?

Gorham: That's true, it's a good point. I mean, we all still need to drink regardless of how much income we're making. But Hansen's problem is that it's so focused on the energy drinks. These are premium-priced drinks. And so consumers have been switching--"trading down," it's often called--from these high-priced drinks to a cheaper alternative.

Kobayashi-Solomon: I see. And I think one of the other things that I've noticed is a lot of these are sold at gas stations or 7-11s. It's kind of an impulse purchase for people. Right?

Gorham: Absolutely right. It's a functional drink, so sometimes customers will specifically go to buy a drink that keeps them going for the rest of the day. But often we'll find that consumers buying in these channels, convenience stores, do so as an impulse as they get to the checkout.

Kobayashi-Solomon: I see. Now, I want to talk a little bit about catalysts. This is not a terribly long-duration bearish strategy. So some kind of near-term influences might prevail. One thing that I've seen lately is sugar prices have been really going up; they're peaking right now. And I think that that's probably a bearish catalyst.

First do you agree with that? And also, do you see any bullish catalysts?

Gorham: In the short term there's a chance that the prices may come down. I've seen since the turn of the year supply conditions improving in Asia and other parts of the world. But it may take some time for that to filter through.

Kobayashi-Solomon: Kind of work through the system. Right, yeah.

Gorham: Exactly. So in the longer term I do think a large manufacturer like Coke of Pepsi might be interested be in the firm. But particularly Coke.

Kobayashi-Solomon: From a bullish perspective, in other words. Maybe like a buyout or something.

Gorham: Right. Exactly. Particularly Coke, with its distributor just having signed that agreement with Hansen. So it has a good product, a strong brand. The brand is really outperformed the rivals over the last few years.

Kobayashi-Solomon: Yeah, their marketing is great, right? The three claws.

Gorham: Great marketing, yeah. And it's even overtaken Red Bull in the last two years or so. It's a great brand, it has quite a strong cash position. It might be attractive to a company like Coke if they choose to go down an acquisition route rather than trying to push their own brands of energy drinks.

Kobayashi-Solomon: You know, actually, this brings me to a nice thing about options and investing with options. Because we've set this up as a call spread, selling a call spread. So our upside is actually limited. So if Coca-Cola does decide to buy them, we've at least limited our upside risk.

Gorham: Right.

Kobayashi-Solomon: Phil, thanks a lot for coming. I really appreciate it.

Gorham: My pleasure.

Kobayashi-Solomon: And thank you for stopping by. Please come by the Morningstar OptionInvestor website, where we have many more great ideas to incorporate options into your investing portfolio.

Erik Kobayashi-Solomon does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.