by Anthony Mirhaydari
July 14 2008
Soft-drink companies are bracing for a slowdown in what has been a surefire moneymaker: Selling filtered tap water, straight up or with flavor and nutrients as "enhanced water" beverages. But the companies still offer opportunity for investors.
Not only are people shying away from water costing the equivalent of $12 a gallon when gasoline is over $4 a gallon, but environmental sensitivity to those ugly, non-biodegradable plastic bottles is on the rise as well. A recent survey by venerable Morgan Stanley beverage analyst William Pecoriello found 16% of consumers are reducing bottled water consumption due to environmental concerns. This is up from just 5% last year. Of these, 34% are reusing their plastic water bottles more often while 23% are just going with tap water instead.
It's no wonder this trend is emerging: A recent report by the Swiss Gas and Water Association finds that bottled water has 100 times the environmental impact of tap water. The Sierra Club notes that bottled water produces 1.5 million tons of plastic waste each year -- the vast majority of which ends up in our landfills and oceans.According to two oceanographers with the British Antarctic Survey, while strolling along the shores of Spitsbergen Island up in the Arctic ocean, where mankind’s doomsday Svalbard Global Seed Vault is located, one can find a piece of plastic detritus every 15 feet or so.
Consumers are also shying away from this largely discretionary expense. Minyanville's Kevin Depew thinks a changing social mood "will seek to portray this as a war against waste and excessive cost, but it's actually grounded in the psychological need to vilify the old signs of overconsumption in order to accept the reality of cutting back." In this case, Bling water, which costs the equivalent of $200 a gallon and is hand decorated with Swarovski crystals, is probably the high-water mark.
Stories like these will continue to attract attention, exacerbating the threat to a sector dependent upon durable and disposable packaging. Already, a number of municipalities are taking steps to banish bottled water through marketing campaigns, as in Vancouver B.C., or by outright political muscle, as is the case in San Francisco, Chicago, and Seattle.
For investors, this is especially problematic because water and enhanced water products drove the mid-single digit annual growth rates seen in ready-to-drink beverages over the last few years (at a time when sales of traditional soft drinks were on the decline). Pecoriello now expects lower long-term volume growth of around 2.3%, with a more bearish scenario seeing sales flat-line for the next five years.
In a volume game like this, sales slowdowns always have an outsized effect on profits. So, unless prices can be increased, operating costs cut, or marketing budgets slashed, the companies in this space will continue to have trouble. The sellers of concentrate, such as Coca-Cola and PepsiCo, could be looking at a margin contraction on the order of 5% by 2011 according to the analyst. The damage to the bottlers, such as Pepsi Bottling Group and Coca-Cola Enterprises, could be three times this amount.
What an unfortunate turn of events for an industry that thought it found the answer to the health concerns of traditional sodas. But not all is lost: Corn-based plastics, such as those already used by Wal-Mart and developed by Cargill, could be an environmentally-friendly solution to the packaging problem. When combined with relief on the cyclical front, severely discounted shares in this sector could make attractive value plays.