Monster Beverage (MNST) is a maker of energy drinks that are sold worldwide. We are neutral on the stock.
Management Efficiency
A fun fact about Monster is that it is considered one of the fastest 100-baggers in history. It took the company only 9.5 years to see 100x growth in stock price. Such impressive growth is very rare and unexpected from a beverage company, especially when we look at the competition.
One of Monster’s direct competitors is Red Bull, which is very popular across the world. In addition, Coke (KO) and Pepsi (PEP) are iconic brands that also own many other labels.
In order to achieve such astonishing growth, a strong management team is required to effectively allocate capital to profitable projects.
We believe we are able to get a good picture of management’s effectiveness by simply looking at the numbers. A metric we like to look at is the economic spread which is defined as follows:
Economic Spread = Return on Invested Capital – Weighted Average Cost of Capital
The idea is very simple; if the return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing money into risk-free bonds.
For Monster, the economic spread is a follows:
Economic Spread = 24.6% – 8%
Economic Spread = 16.6%
As a result, the company is creating value for its shareholders, implying that management is efficiently allocating capital.
Valuation
To value Monster, we will use the H-Model, which is similar to a three-stage DCF model. The H-Model assumes that growth will decelerate linearly over a specified period of time. We believe this is a reasonable assumption as companies gradually slow down as they mature. The formula is as follows:
Stock Value = (CF(1+tg))/(r-tg) + (CFH(hg-tg))/(r-tg)
Where:
CF = cash flow per share
tg = terminal growth rate
hg = high growth rate
r = discount rate
H = half-life of the forecast period
For Monster, we used the following assumptions:
CF = $2.65 per share (based on Fiscal Year 2021 estimates)
tg = 2.055%
hg = 11.0% (based on analysts’ estimates)
r = 6.639%
H = five years (we are assuming it will take 10 years to reach terminal growth)
As a result, we estimate that the fair value of Monster is approximately $84.85 under current market conditions.
Risks
It appears that the main risk for Monster at the moment is its valuation. Although the company is highly profitable with a large economic spread, it is trading above our estimated fair value. This is concerning because, under current market conditions, the discount rate we used was low.
As a result, if the company is already above fair value in the current environment, then it means it is more vulnerable to drawdowns when rates begin to rise as they are expected to. Therefore, investors need to keep this in mind if they choose to pick up shares of Monster.
Wall Street’s Take
Turning to Wall Street, Monster has a Strong Buy consensus rating, based on 11 Buys and two Holds assigned in the past three months. The average Monster Beverage price target of $107.91 implies 20% upside potential.
Conclusion
Monster is a strong company that has rewarded its long-term shareholders very handsomely. However, it will be difficult for the company to replicate that success from this point on.
In addition, our fair value estimate for the company indicates that it may see some medium-term headwinds as the current price may be stretched. As a result, we are neutral for time being.
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