Wall Street Smarts 2005: Diet CSDs, Energy Drinks,
Water and Consolidation Dominate Discussions.

At BD's Wall Street Smarts conference June 13, several key themes emerge from presentations. Diet CSDs. Will volume slowdown this year continue, or will diets return to strong growth? Energy drinks. Speakers discussed potential size of category, user demographics and whether high pricing will be sustained. Deals and consolidation. Indications are, according to two speakers, no major U.S. deals on horizon, but some opportunities remain for smaller U.S. deals and deals abroad. Water growth and pricing. Category growth remains strong, as prices continue to decline. CD-ROM. Click here to order a CD-ROM transcript.

Speakers. In order of appearance: 1) Irial Finan, executive vp, Coca-Cola Co and president Bottling Investments. 2) John Faucher, beverage analyst, J.P. Morgan. 3) Cie Nicholson, vp marketing non-carbs, Pepsi North America. 4) Marty Ruffalo, senior vp sales, beverage cans and PET, Ball Corp. 5) Caroline Levy, beverage analyst, UBS. 6) Rodney Sacks, CEO, Hansen Natural Corp. 7) Leon Kalvaria, managing director/head of consumer/healthcare investment banking, Citigroup. 8) John Sheppard, CEO, Cott Corp. 9) Bill Pecoriello, beverage analyst, Morgan Stanley. 10) Terry Marks, president North America, Coca-Cola Enterprises.

Diet CSDs.

So far this year, syndicated data shows significant growth slowdown of diet segment. Diets have been bulwark against ongoing decline of regular CSD volume in recent years. Coke's Finan: "We should not take a short period of time and start saying it is the death of diets. The last five years have been very dynamic for diets. For the first five months of this year, they have been weaker then we would like, (but) we are cycling (early 2004 rollout of) Diet Coke with Lime." Adds: "I am very optimistic about the future of diets." Finan and CCE's Marks also express optimism about two new Coke diet colas: Coke Zero and Diet Coke with Splenda. Call Coke Zero broad-appealing product aimed at current regular cola drinkers and "lapsed" cola fans. Diet Coke with Splenda described as aimed at consumers who have interest in sucralose.

Plus. Marks adds: "We believe that when we see innovation kick in, we'll see diet growth." Says Diet Coke with Splenda "exceeded projections in May by 50%." Adds that CCE "absolutely (is) committed to giving our diet category more (shelf) space." Beyond two new diet colas, Coke also rolls out two new varieties of Fresca. UBS' Levy, asked her opinion re diet CSD prospects says, "I know CCE feels a lot better about Coke Zero than they did about C2." Morgan Stanley's Pecoriello forecasts volume impact of new diet colas. Suggests Pepsi One will have 58% cannibalization rate (meaning that it will be 42% incremental). Coke Zero 63% cannibalization; Diet Coke With Splenda 64% cannibalization. Suggests Coke Zero will reach annual volume of 153 mil cases in 1st 12 months after launch; Diet Coke With Splenda 29 mil cases; Pepsi One 26 mil cases.

Energy Drinks.

Hansen. Sacks describes evolution of Hansen's from juice and juice-drink company to major player in energy drinks. Company's Monster brand launched in 2001 to take on leader Red Bull by offering "twice the buzz or the boost of Red Bull" and twice the ounces at same price. Company also launched "Lost" brand energy drink to compete with Rockstar's more youthful demographic. Sacks notes energy drink category is still evolving: "We believe this is a product driven by personality ... I'd rather get to fewer consumers but get to them with a message." Hansen's is also testing "retailer brand" energy drink "Joker" for Circle-K C-store chain. Asked if he'd consider a sale of company, Sacks replies: "I have no preconceived ideas about whether we won't sell or we will sell. The right deal would have to come along."

CCE. Marks notes that CCE projects small-volume, premium-priced energy drinks will have significant dollar growth in 2005-2008. Energy drink profitability at current price levels is 8x CSD, he says. Adds initial rollout of Coke's Full Throttle "has surpassed our expectations," and new distribution agreement for Rockstar bodes well for summer. Notes "getting serious about energy" drinks has invigorated entire CCE system this year, and "we want to be a strong #2 in this category." Asked if energy drink pricing will fall if large competitors chase volume/share, Marks declares: "I don't think that (energy drinks category) will ever be the volume category that water and CSDs are, because of the nature of the product." Adds: "We would much rather see the category evolve at the current pricing structure." UBS. Levy says energy drink sales in supermarkets total $243 mil through mid-May, up +76%.

Pepsi. Nicholson describes Pepsi's "energy portfolio" as including two SoBe energy drinks, Mt. Dew AMP and Starbucks Double-Shot coffee/dairy drink. Notes portfolio is currently #2 in share behind Red Bull. Says energy drink demographics skew 70/30 male-female overall and 80/20 male-female for 16-oz format. Asked to assess category, she says, "there is great potential, (but) we'll see how high is up." Coke. Finan says company "is going to be a key player in the energy category, and we expect over the next three or four years it will be a very dynamic category." Re Coke's new Vault hybrid citrus/energy drink (BD 6/10/05): "It is a great product, and I think there are great prospects ... I am sure we will stick with it in the long term." Ball. Ruffalo reports "energy drinks are having a very significant impact on our business" this year with 8-oz, 16-oz and 24-oz cans "up double-digits." Cott. Company has launched "Red Rave" energy drink for Canada customer Loblaw. Sheppard adds company "in discussion with a number of customers right now" re energy drinks in U.S. and also talking to C-store chains.

Water.

Water. Pecoriello says Morgan Stanley's recent survey of U.S. consumers indicates on-going shift to bottled water from CSD, with net +24% drinking more water in past six months vs -12% for regular CSDs and -2% for diet CSDs. Estimates 64% of bottled water growth comes from CSD's. He also expresses concern about continuing price erosion for water, suggesting: "Bottled water will continue to capture majority of cases lost by CSDs, but is a less attractive category until greater brand equity and pricing power can be built." Levy: "C-stores love selling water."

Pepsi. Nicholson says Pepsi is very positive on new Aquafina flavored and sparkling versions, and shows new TV ads backing rollout of products. She also says last year's West Coast test of low-priced water under H₂O brand has been "shut down." CCE. North American chief Marks was asked about Coke's "three-tier" water strategy -- Dannon for low end, Dasani in middle and Evian as premium-priced -- and replies: "There was a belief that there would be three tiers ... The fact is that the floor has collapsed so much that perhaps three tiers don't exist anymore."

Deals and Consolidation.

J.P. Morgan's Faucher offers insights on bottler consolidation and notes Coke's top-10 U.S. bottlers handle 95+% of volume and Pepsi's about 90%. Says additional deals will proceed slowly, as Wall Street concentrates on ROIC (return on invested capital). Bottom line: "We're not expecting a lot of deals" in North America, but "there is a lot of opportunity" internationally. Citigroup investment banker Kalvaria focuses on franchisors and says he doesn't foresee major U.S. beverage deals, because "all the big deals have been done." Asked about Danone being bought or merging with one of big-3 CSD companies, Kalvaria expresses doubt, noting that "Danone is not just a beverage company, it is also one of the great French treasures." As for Hansen, Kalvaria says huge increase in stock price may scare buyers away for now: "Usually people don't like to buy companies whose stock price has gone up 10x." Asked about PepsiCo-Quaker deal, notes: "It's one of the most interesting corporate transformations to have occurred in the last 20 years."

Packaging.

Ball's Ruffalo touches on some key package/price dynamics: 1) suggests declining recycling rates for aluminum/PET is "major problem" and that without deposit-law states' higher recycling rates, national rates "would be much lower." 2) shows new can with inside mechanism for releasing flavor or nutrients from dry state when can is opened. Product now being used by Brain-Twist for development of vitamin-containing product "Defense." 3) "holy grail" for packaging business is cost-effective re-sealable 12-oz can for CSD's. 4) Regarding aborted efforts in 1990s for shaped cans: "I think it's going to be very difficult to find a shaped can that's going to be cost-effective and work in the marketplace." Plus. Cott's Sheppard focuses on North American PL market and presents case for future significant share growth based on PL's shares in other markets.