MI373: Valuing the Best Stock of the Last Three Decades w/ Shawn O'Malley

0:00You're listening to TIP. Hey guys, welcome back to the Millennial Investing Podcast. I'm your host today, Sean O'Malley. I'll be continuing my series on breaking down some of the best-known companies and markets, as I've done in recent episodes on S &P Global, Alibaba, and Disney. Today, I'll be focusing on one of the best-performing stocks of the past 25 years, Monster Beverage. As surprising as it might sound, this energy drink company has consistently delivered returns that crush those generated by the best-known companies and markets like Apple, Amazon, and Microsoft. As crazy as it really is, the only stock to beat Monster's returns over the past two and a half decades is NVIDIA.

0:38If you had invested$10 ,000 in Monster in 1999, that investment would be worth roughly$11 million today. It really is just an incredible story, and I want to break down how Monster has been able to go on such an incredible run while also discussing its current valuation and whether its stock still offers good value to investors. After debuting at a share price of less than a nickel, Monster stock has risen by over 200 ,000 % since then. Monster has compounded returns for shareholders at over 27 % per year since 1992, at almost 21 % per year since 2010, and at around 10 % per year since 2020. But that compounded annual return since 2020 is brought down by a slump over the past year, as Monster sits near its 52-week lows here at the time of recording.

1:24So with this recent slump, I want to discuss whether this is an opportunity for investors. I find it fascinating to uncover these sorts of stories in markets. Whether you like their energy drinks or not, it's worth better understanding how a beverage company can stack up these kinds of really mind-numbing returns. And while plenty of people have kicked themselves for missing out on this big winner, that doesn't necessarily mean Monster can't continue to compound impressive returns. With that, let's get right into it.

1:54Celebrating 10 years. You are listening to Millennial Investing by the Investors Podcast Network. Since 2014, we have been Value Investors' go-to source for studying legendary investors, understanding timeless books, and breaking down great businesses. Now, for your host, Sean O'Malley.

2:22As mentioned at the top of the show, I'll be going through the story of Monster Beverage, how it's doing today, and how to think about its valuation. Monster Beverage Company is best known for its Monster Energy drink. These are sort of the classic energy drinks you might think of as an alternative to Red Bull, with their black and green cans that have three claw marks forming the letter M. The logo itself does deserve some mention. It has remained unchanged for over two decades, and it's easily one of the most recognizable products out there, especially in the beverage industry. It really creates a feeling of mystery and intrigue that has clearly resonated with people.

2:56Even just the sinister font used to write out the word monster is pretty identifiable. Obviously, the product itself has to be appealing too, but the product design is something of a masterpiece in marketing with a bunch of Easter eggs hidden in that design. Monster Beverage hasn't always been about energy drinks though, and it hasn't even always been called Monster. The original company was actually founded as Hansen's in 1935, selling juice products, and it didn't rename itself Monster Beverage until 2012. The story starts pretty humbly in Southern California with Hubert Hansen and his three sons selling juice to film studios and local retailers.

3:32They loaded up an old flatbed truck and drove down dusty roads with heavy crates of juice during the Great Depression to deliver to their customers. It stayed a family business for years, and in the 1970s, Hubert's grandson, Tim Hansen, took over control of the company and developed a handful of sodas and juices to market under the Hansen brand. After the company fell into bankruptcy in 1988, it was acquired by two South African billionaires, Rodney Sachs and Hilton Schlossberg, and renamed Hansen Natural Company. Those two have actually run the company ever since, with restructured leadership and a fresh investment into the business to help turn things around and brought the company to IPO in 1990.

4:11But it wasn't until after more than six decades of existence that Hansen's launched its first energy drink in 1997. It was at least partly a story of being in the right place at the right time. As America embraced the internet and rapid technological change, energy drinks became a popular and fitting addition to many people's lives. The monster energy drink known and love today would be released in 2002, and it leaned heavily into a surge of patriotism and support from the military following 9-11. That branding helped Monster gain a cult following, and its products have held onto impressive market share ever since.

4:45So Monster Energy really changed the company's trajectory. In 2001, the company made just$92 million in revenues, and in over two decades, sales grew to over$7.1 billion last year. That is a compounded annual growth rate of 20 % per year. Nick Modi of RBC Capital Markets had this to say about Monster Energy's rise to CNBC, quote, they built it the right way. They were very slow and methodical in how they built the distribution of the brand, making sure it was strong in every market that it was in, and every retailer that was in it was getting good velocity. So it's a brand now that people are just really passionate about.

5:23There's a whole subreddit with over 40 ,000 members devoted to just showing off their can collections and discussing their flavor preferences. It's funny how a single product's success can completely change the face of a company. I'm going to guess that Hubert Hansen in 1935 had no possible clue that his little family juice business would become one of the largest energy drink companies in the world in the 21st century under a completely different name. Monster Beverage employs some 6 ,000 employees across the globe now, thanks largely to rolling that success with Monster Energy Drinks into related product lines.

5:57It's also worth mentioning that Monster has been a controversial product. There have been a few different scandals connected to it, premised around it basically having too much caffeine and therefore being too dangerous. I am evidently not a medical expert, but the consensus seems to be that like anything really, Monster is safe in moderation. Each can has two servings worth of liquid and the total caffeine content in a can is around 160 milligrams. For reference, a single 8-ounce cup of coffee has about 95 milligrams of caffeine. So a full can has around the same caffeine as between one and two cups of coffee.

6:30Despite some instances of people dying from cardiac-related issues after consuming the drinks, these cases have largely involved underlying conditions, and the European Food Safety Authority has concluded that reasonable consumption of Monster and other energy drinks is safe and unlikely to interact adversely with alcohol or the other ingredients in its drinks. And a 2013 US Senate hearing on energy drink risk has resulted in no changes to the industry. However, some countries already have in place bans that restrict energy drink sales to anyone below a certain age, usually either 12 or 18, depending on the country.

7:02So there is definitely a risk of further regulation and restrictions. And that is one of the things that bears like to point out about the stock. Proposed legislation has ranged from excise taxes, making energy drinks more expensive in certain areas to limits on how much caffeine can be included in a single drink, which might make them less appealing to some customers. I've tried Monster, but that much caffeine just isn't for me personally. I don't even really drink coffee though, so I am a biased audience. That said, I can understand why people love them. There are plenty of people who aren't particularly sensitive to caffeine side effects, who like the flavor, and who find that the drinks keep them energized and focused throughout their days.

7:39I would never encourage anyone to drink energy drinks, but again, I see why they exist. Caffeine is ultimately a highly addictive drug, even if it's quite normalized, and anyone investing the company would have to come to terms with that. Because caffeine is so addicting, Monster is arguably a consumer staple company as opposed to being a consumer discretionary one. In a recession, people are almost certainly not going to cut back on their caffeine consumption. There's probably a long list of things the average Monster consumer would cut spending on before they gave up their Monster energy drinks.

8:08For many, it's their equivalent of a morning coffee habit, except with Monster, there's not an option to make it yourself at home. It might not be as much of a staple as something like toilet paper, as there are some substitutes for Monster, but I don't think it's a stretch to lump Monster into this category either. Monster's CEO actually frames a product as a quote, affordable luxury. Let's take a quick break and hear from today's sponsors. Even Einstein had blind spots. That's why modern science is built on the idea of peer review. Investing may be more art than science, but that doesn't make peer feedback any less valuable.

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11:14And for a limited time, you can use code STOCKS15 for a 15 % discount at checkout. All right, back to the show. After Monster Energy had made a lasting impact on the beverage industry, it caught the interest of beverage giant Coca-Cola. Coke and Monster entered into a strategic partnership in 2015, and Coke purchased a 16.7 % stake in the company for over$2 billion, which has grown to more than 20 % today due to buybacks. Coke became Monster's preferred global distribution partner, and they traded ownership of a few brands too. Monster received Coke's energy drink brands, NOS, Full Throttle, Burn, and Relentless, while Coke got Hansen's Natural Sodas, Peace Tea, and Hubert's Lemonade.

11:56From Coke's perspective, swapping brands and investing in Monster was an efficient way to gain exposure to the growing market for energy drinks, while Monster was quite pleased to get access to Coke's industry-leading distribution networks. In the beverage world, what really prevents some popular products from going mainstream is distribution. Over decades, this is something companies like Coke and Pepsi have really come to dominate, and if you can't get space in their distribution network since trucks can only carry so many drinks at a time, then there's little hope of your product finding nationwide or worldwide success.

12:27Distributors are almost like a brand sales team working to establish relationships with retailers and to ensure inventories end up where they're supposed to go. So Monster's relationship with Coca-Cola gives it a pretty meaningful competitive advantage over smaller brands. Monster investors did panic a bit though in 2018 when Coke announced that it was planning on releasing energy drinks under its own brand name. While Monster and Coke's original partnership deal restricted Coke from competing in the energy drink category, it was permitted to do so with certain exceptions. But Coca-Cola Energy, as it was called, was short-lived and was discontinued in North America in 2021.

13:03Today, Monster remains focused on the energy drink business, with a range of brands starting different niches. You might recognize some of them like Rain, spelled R-E-I-G-N, and Bang, as well as Predator Energy and Full Throttle. Bang, for example, targets a very different audience than Monster. Its website pops with colors of pink and purple, pictures of chic female influencers, and flavors like Radical Skedaddle and Sourheads. It's got a fun, almost 1980s-era feel to the marketing. While Predator Energy takes a pretty different approach, the website is dark and welcomes you with a short video of its Flaming Tiger logo and offers flavors like Mean Green and Purple Rain.

13:42It is meant to deliver greater value and targets more price-sensitive consumers. Another one of its brands, Tor Water, is marketed as the quote, original backstage water, and its cans are adorned with art that resembles the posters you might see at a rock and roll concert. It is literally just water, but in a cool can, so you don't feel insecure about not drinking something sexier. And then there's Monster's Canarchy brand, which has 585 employees and brews a variety of drinks like hard tea and hard seltzer. This includes some recognizable drinks like Highly and Dale's Pale Ale, but that's sort of the lay of the land with Monster's product lines.

14:16I'll just mention what the competition looks like too. Obviously, there's Red Bull, but the other big player in this market is PepsiCo with their rockstar line of energy drinks. Energy drink companies earned about$21 billion in sales globally last year, with Monster and Red Bull being the two biggest companies in the space, holding between 20 and 30 % of the combined market share, depending on how you define the market size, either in terms of sales volumes or sales dollars, and what types of drinks you classify as energy drinks. Pepsi's share is below 10 % and the remaining market is captured by other brands like Celsius and Ghost.

14:50You might also argue that the addressable market for energy drinks has some overlap with coffee consumers. So in some ways, coffee also competes against Monster, especially for the types of canned coffee drinks featured near energy drinks in stores. But Monster does have its own line of canned coffee energy drinks called Java Monster. Monster also primarily competes in the US, which is where about 60 % of its sales come from, though it distributes its products across 142 countries. So there is considerable opportunity to try and change consumer habits worldwide by introducing and popularizing energy drinks in new markets.

15:23But there is, as always, no guarantee that Monster will catch on in popularity like in the US. And while Monster has ventured into other areas like alcohol, its energy drink business still represents more than 90 % of its sales. But consumption habits around energy drinks have really changed considerably in recent years. What was once considered something primarily relied upon by college students cramming before a test has very much gone mainstream. People sip them casually at concerts, on the way to work, at the gym, and anywhere really. And energy drinks purporting to have certain vitamins, electrolytes, and other health benefits have caught on with specific consumer niches as well.

15:58So energy drinks broadly have come to represent about 20 % of the overall beverage industry. This growing popularity also means more and more brands piling into the space, which will continue to pressure profit margins. So Monster's profit margins have held up well so far, which is a testament to its brand power and customer loyalty. Its gross margins are at 53.5%, just a hair below where they were in 2014 at 54.4%. And its net profit margin has actually risen over that same period from 19.6 % to 28.2%. Celsius is one of those brands that has really broken through in recent years and has a quite different feel from Red Bull or Monster.

16:38It's not about extreme sports and isn't intensely masculine. You might say it doesn't even really look like an energy drink. The company completely reinvented itself after teetering on the verge of bankruptcy a decade ago and is now worth around$9 billion. While Celsius is going after different customer segments, it's hard not to see the fastest growing company in the energy drink space as a threat. Celsius promotes itself as more of a functional beverage and health supplement, and in its early days, it framed itself as something of a magic weight loss drink to combat the obesity epidemic. Celsius has much stronger appeal with women than Red Bull or Monster, and combined with its fit image, it's a type of drink you might see at a SoulCycle class.

17:17Similar to how Monster has partnered with Coke, Celsius has partnered with Pepsi, so Celsius, I think, is a significant player in this space to keep an eye on. In terms of the economics of the business, Monster outsources key processes to third parties like bottling, packaging, and distribution. So that leaves Monster responsible for designing flavors and marketing its products, as well as purchasing the raw ingredients, flavors, juices, cans, bottles, and caps that are used for its products, which are then delivered to bottlers and packagers. In 2016, Monster took more direct control over its production of flavors by acquiring the American Fruits and Flavors Company for$690 million, which had supplied Monster's flavors for 20 years.

17:57The deal enabled Monster to take ownership of intellectual property related to flavor development and its products. Monster Energy breaks its business into three primary reporting segments. The largest is its Monster Energy segment, which includes its signature Monster drinks as well as Bang. Monster's second segment is what they call their strategic brands unit, which includes the various drink brands acquired from Coca-Cola in 2015. This unit primarily generates revenues by selling concentrates and or what you might call beverage bases to authorize bottling and canning operations. Such bottlers generally combine the concentrates with sweeteners, water, and other ingredients to produce ready-to-drink packaged energy drinks.

18:32The ready-to-drink packaged energy drinks are then sold to other bottlers, full-service distributors, or retailers, which includes grocery chains, wholesalers, convenience stores, drugstores, e-commerce retailers, and even the military. The third unit, which is really quite small, is its portfolio of alcohol brands. Monster has really only just dipped its toe into this area, but its sales of alcoholic drinks did grow 80 % from 2022 to 2023. It's worth taking a moment to explain what bottlers do. Beverage bottlers prepare, fill, seal, label, and distribute beverages for sale. They also ensure quality control and compliance with regulators like the FDA.

19:09The bottling process involves cleaning and sterilizing bottles, mixing drink ingredients, filling them, sealing them, labeling them, and packing them for distribution. Bottling lines often include equipment for applying labels, capping, date stamping, and quality assurance verification. Many bottling companies are actually franchisees of Pepsi and Coca-Cola, and Coca-Cola has its bottling operations split into separate companies. If you try to look up the Coke stock, you'll find that there are two different listings, one with the ticker C-O-K-E and one with the ticker K-O. The first one is actually the company that does bottling for Coke products and other beverage brands, whereas the second one, ticker KO, is the company that owns the intellectual property for Coca-Cola and is what people usually reference when they talk about the Coca-Cola company.

19:53But Coca-Cola actually has over 250 bottling partners worldwide. And funny enough, the vast majority of delivery trucks plastered with the Coca-Cola logo actually belong to bottling companies that license the logo, not the true Coca-Cola company with the stock ticker KO. The bottlers undoubtedly have the worst end of the deal as they have to purchase and maintain manufacturing and distribution equipment while also having to pay companies like Coca-Cola and Monster a vast portion of their income. Similar to how the parent company that owns the intellectual property for Coca-Cola realized it would be more profitable to outsource bottling and distribution to separate companies, rather than taking on those logistics within their own business, Monster has followed that same playbook.

20:33Part of Monster's business has been to become something of a trademark bully too. They're understandably very protective of their brand, so they've been known to launch no shortage of often frivolous lawsuits that they usually lose. This does send a powerful signal though to anyone who might seriously consider infringing upon their intellectual property. Monster has over 21 ,000 trademarks worldwide, and it's obviously keen to protect them. Marketing is also a big component of building and protecting its brand too. They largely focus on reaching their target audience of younger, typically more blue-collar consumers through promotions of extreme sports, from F1 racing to MMA, gaming, and bull riding, helping the brand become more emblematic of a certain lifestyle.

21:14This is actually quite similar to Red Bull's influencer-led strategy where extreme sports athletes are paid to recommend and drink the beverages. But Monster isn't sold in bars as this becomes so popular with vodka Red Bull cocktails and it isn't really marketed on TV. Monster's focus is on what can be accomplished by drinking their products and letting the product speak for itself. There's actually very little capital tied up in the operations of the business since Monster Beverage is a holding company for each of its different brands. From the top down, Monster Beverage's job is primarily to manage and market these different brands to consumers.

21:48What's also attractive about this business is that once a hit drink has been successfully brought to market, there aren't really any incremental updates needed. Technological companies essentially have to upgrade their offerings every quarter or every year, yet that's not really the case in the beverage industry. There is a lot of effort that can go into launching new brands and testing those products, but it's not like they have to reinvent the formula for Monster energy drinks every six months either. Compared to other consumer brands, part of what has enabled Monster to generate such stellar returns is that it's so asset light, doesn't have any manufacturing facilities, and it doesn't have to distribute its products either, thanks to Coca-Cola.

22:23They've been able to take this master Monster brand and reformat it across a number of segments in the beverage industry to their benefit. Determining the outlook for a consumer-facing brand like Monster can be hard. There are things that are out of their control, like the cost of aluminum or sugar, as well as regulations that can limit where and to whom they can sell their products. On top of that, there are also competitive dynamics, as in will energy drink companies undercut each other excessively for market share such that everybody in the industry is a loser, or will there be an equilibrium of tacit collusions where each drink maker sort of cars out their own customer niche?

22:56In my opinion, one of the best and most reliable ways to assess business quality is in pricing power. If a brand raises its prices, you'll see real quickly just how much customers care about it, it raises prices and a competitor's sales promptly see an unexpected surge, then you know that the product's loyalty and positioning is weak. Companies that can raise prices to a degree that actually boosts profit margins without an offsetting decline in sales volumes have pricing power. And the ability to do that encapsulates a confluence of factors from effective marketing to product quality and brand perception.

23:28On that point, Monster plans to raise prices for its core products by 5 % across the board starting November. So the fact that they're confident about doing that tells you something about how management thinks about the company's pricing power, though obviously we'll see what happens when the hikes are implemented. A challenge for Monster is that with its blue collar reputation, it doesn't have the same premium customer base as Red Bull does. At Walmart, a 12 pack of Red Bull sells for 21.8 cents per fluid ounce, or then double what Monster charges at 10.4 cents per fluid ounce for a 12 pack. Its customer base may be less willing or less able to absorb price hikes to the same degree, which is a hard limit on pricing power for Monster.