Inflation-Proofing Contracts Propel Keurig Dr. Pepper's Profit Margins

The company saw the biggest gross margin expansion in four years.

How much do contracts matter? If you're Keurig Dr. Pepper—a lot.

In its 2023 third-quarter earnings call, Keurig Dr. Pepper detailed how renegotiations of private label manufacturing contracts led to an expansion in adjusted gross margins. These contracts, which previously failed to account for inflation in their fixed pricing structures, have been restructured to allow for the pass-through of increased costs, mitigating the adverse impact on the company's profitability. CEO Robert Gamgort emphasized the importance of these changes, telling investors, "that's all catching up right now, and you're seeing that flowing through."

The change pushed Keurig Dr. Pepper's gross profit margin up by 100 basis points compared to the same period last year, the most substantial annual increase in the previous four years. "We've now adjusted all of those agreements going forward," Gamgort said, "and we don't expect a substantial lag between pricing and inflation to occur in the future."

Net sales also reflected positive growth, with a 5.1% rise to $3.81 billion for the quarter, up from $3.62 billion in the corresponding period the previous year. This growth was propelled by a 5.5% price increase, slightly offset by a volume/mix dip of 1.4%.

Moreover, the company's GAAP operating income experienced a dramatic increase, soaring by 127.4% to reach $896 million, a significant leap from the prior year's $394 million. This leap was super dramatized by a non-recurring impairment charge that depressed last year's figures.

Inflation is shifting purchasing habits but not impacting demand.

• Keurig Dr. Pepper management indicated a shift in consumer shopping habits, with discount retailers and value-oriented channels taking advantage.

• There's a noticeable trend of lower-to-middle-income households gravitating towards at-home food and beverage consumption, pushing up sales of sodas and coffee.

Keurig Dr. Peppers jumps into sports hydration with Electrolit.

• KDP announced a distribution deal with Electrolit, a Mexican sports drink brand.

• The brand, which sells 20 oz bottles for around $2.50, already boasts annual sales of $400 million in the U.S. That's a ten-fold increase in the last five years. It already dominates the Mexican market.

• Management expects it to boost revenue in its initial year at KDP, with profitability contributions projected for its second year.

The first rational take on GLP-1 Data

• Several different retailers and manufacturers have credited sales changes to the rise of Ozempic and other weight loss drugs.

• "I would caution everybody that the data that is actually available is really limited at this point," CEO Gamgort said.

• Preliminary data suggests neutral to potentially positive impacts on beverage consumption patterns, with no evidence of declining drink sales linked to GLP-1 usage.

They said it.

CEO Robert Gamgort on private label manufacturing contracts:

We had a number of conversations in the past, as you'll recall, about the gap between pricing to partners and private label versus the inflation that we were experiencing that had never been contemplated in the prior years in which we had signed those agreements. And remember, that's very different than pricing that you see at retail, just to be clear, because I know when I say pricing, people immediately go to retail pricing. What I'm talking about is the contractual pricing that we have with partners and private label, who then in turn set their own retail pricing as a result of that.

And so we said that there was a lag, but it would flow through. It's flowing through. We have great visibility to it going forward, to answer your question, because it's contractual. And I think the other point to make and it's an emphasis of the prepared remarks is that we've now adjusted all of those agreements going forward and we don't expect a substantial lag between pricing and inflation to occur in the future.