Celsius Holdings: Wonderful Business Execution

Celsius Holdings (NASDAQ:CELH) has been one of the best-performing stocks in the market over the last couple of years. Due to recent falls, the valuation is only 40% higher than its lows, experienced in March 2023, despite the fact that the price is 88% higher than those levels. This is due to the excellent execution of the business, which has managed to grow sales by more than 100% in H1. I think it is very likely that Celsius will continue to grow strongly over the remainder of the decade, making it an interesting stock in an easy-to-understand sector.

Business model

Celsius Holdings is dedicated to selling and marketing functional beverages. Functional drinks are those that offer health and self-care benefits: vitamins, minerals, etc. On the other hand, energy drinks, such as Monster (MNST) or Red Bull, contain stimulating substances to improve physical and mental resistance as well as reduce exhaustion. Celsius' drinks also have caffeine and stimulant substances, but their products are much better perceived than those of its rivals since they are associated with healthier, 0 sugar and sports drinks. I think Monster is trying to attack this niche with its Reign brand or its sugar-free Monster range, Ultra. Even so, Celsius seems to have a better public opinion, and in a sector in which brand image and distribution are the most important competitive advantages, it can be a differential point. This is being fueled by all the resources that the company is deploying into marketing (around 30% of yearly sales).

If we have already seen that brand image is important, distribution would be the second critical moat in this sector. Last summer, an inflection point for the company was announced. PepsiCo (PEP) will become the official distributor in the US and internationally and will also become the company's largest shareholder, with a stake of $550 million (8.5% of shares outstanding). They have done this by purchasing preferred shares at $75, or around $5 Bn. market cap (today they are trading above $150) and has the right to an annual dividend of 5%. Just to have a reference for the valuation part, Pepsi bought these shares when they were trading between 8x and 9x sales. The same valuation at which Celsius is trading right now. This can be an important indication for later.

This was very positive news for Celsius since it greatly increased its competitive advantages because it now has the distribution fleet, bottling network, and space on shelves and stores that Pepsi has. For PepsiCo it is also positive since it gains exposure to a market segment that is growing rapidly and with a brand that is doing very well, unlike Rockstar (property of PepsiCo). This agreement will not only help it in the USA but will also facilitate its international expansion. Currently, in Europe, it is only available in the Nordic countries, thanks to the acquisition in 2019 of the sports food brand Func Food, which has been its Nordic distributor since 2015. It is already beginning to enter other markets, such as Germany or Switzerland. Monster and Red Bull have between 35 and 40% of sales outside the US; Celsius has 6%. They are focusing on energy categories or countries that are more familiar with those types of drinks, rather than trying to go in and create the category. I think that international expansion will be a great growth channel throughout this decade, since, for example, in my country, Spain, we still do not have Celsius available anywhere.

Energy drinks market

The energy drink market is set to grow at 8.4% rates during the rest of the decade. The American market represents around 25% of this market. That is why I say that international expansion will be a source of growth in the future. According to the company's Q2 presentation (Slide3), Celsius has an 8.6% market share in the US, up from 4.6% last year, and is the #2 largest energy drink in Amazon, just behind MNST. The Twitter user @JonahLupton shared the last nielsen report. According to Nielsen, both Red Bull and Monster each have more than 30% market share. If Celsius maintains these growth rates, we could have an oligopoly situation between the three companies by the end of the decade. Mergers and acquisitions have already begun, such as Monster's latest acquisition of Bang.

Clinical studies

If the company is proud of something, it is being the only brand of functional and energy drinks whose products are backed by studies (6 highlighted in its annual report) that demonstrate their health properties. With its MetaPlus formula, a can of Celsius has been shown to help burn between 100 and 140 extra kcal per workout, as it increases metabolism by 12% on average for 3 hours. As well as improvements in cardiovascular health, fat loss, and muscle gain. Again, we reaffirm that Celsius wants to have a better image than Monster or Red Bull, focusing on the sports or health field. Being associated with a sports drink can be very beneficial for popular opinion and the retail places where it can be marketed. Personally, I do not give importance to this, but I know that there are many people who do, and for that reason alone, they are going to consume Celsius before Monster or Red Bull.

Competence

Celsius competes directly against Monster or Red Bull, but since the second is private and we do not have data on its figures, we will focus on the first. Celsius, like Monster and unlike Pepsi, is an asset light company. It does not own factories or bottling plants, PEP takes care of this, thanks to its new agreement. Celsius buys the raw materials, such as aluminum or flavors, and PEP takes care of bottling and distribution. KO does the same for Monster. This puts Celsius in a prime position to compete against the big boys. As we can see in the table, its figures are more similar to those of MNST. Its margins and returns are a reflection of what we can expect for Celsius in 10 years. On the other hand, PEP differs in almost all figures, but because it is a much more mature and capital-intensive company.

Personal opinion

The good point about having access to this type of product is that you can make reflections in the purest Peter Lynch style. Although unfortunately, Celsius is not yet available in Spain, I was in Sweden as an exchange student a year ago. There, I was able to try all their flavors available in the country and compare them against their competition. Although I generally liked the flavors, I found them all worse than Monster's Ultra range. In addition, it came in less quantity (330 mL vs. 500 mL in Monster cans). They had more caffeine (200mg vs. 160mg in a Monster can) and were more expensive. There is a range called Celsius Heat, which has up to 300mg of caffeine, but I could not find it.

I have spoken with friends who live in the States, and they have told me that everyone likes Celsius there. So mine must be an isolated case. Anyway, I think that energy drinks generate greater customer loyalty because they serve a higher purpose (studying, playing sports, etc.) compared to others like Pepsi or Coca-Cola. This consumption is less discretionary, and I consider its demand more inelastic. They are products that many people consume daily, and once you have found your favorite, it is difficult to change it.

Capital allocation

Because Celsius is in the midst of expansion, it is not surprising that it has not yet distributed dividends to its shareholders or repurchased shares. The life cycle of the business is still at an early stage, so I see it as very positive that they are focusing on investing in marketing (around 30% of your annual sales) and managing working capital in the best way possible (25% of sales). They have issued shares to grow, taking advantage of their high valuations. It does not have a single $ of debt on its balance sheet.

We have also been able to verify that they are good at doing M&A or reaching agreements with important companies. This speaks very well of the management team and makes clear its long-term focus. Furthermore, unlike many growth companies, stock options only represent 6.17% on average of sales over the last 7 years, although the trend is decreasing, which is another positive sign.

Financials

In this graph, we can see the evolution of some of the most important Celsius figures. Estimates for the end of 2023 are also shown. As we can see, the growth in sales is completely exponential. As we have already mentioned before, the strong investment in marketing and working capital makes the EBIT and FCF figures look very low compared to sales. This is part of the life cycle of the business, and the important thing will be to see where they can be in 10 years. A good reference could be Monster, with EBIT margins of 33% on average over the last 7 years and FCF margins of 25% on average over the same period. Right now, they have to be focused on growing the top line, gaining market share, and working on their brand image. And so far, they are executing perfectly.

At the company's Q2 presentation, Celsius surprised everyone with incredible growth rates. The strategy and execution that the company is carrying out seem to work. It is also very positive to see a great recovery in the gross margin and a positive EBITDA. Although they continue to invest heavily in OPEX, the FCF and their respective margins should benefit thanks to the positive EBITDA, which will surely continue to expand in the coming years.

Valuation

This is a point on which I am going to dwell a bit, since the valuation of this type of companies that have not yet generated profits can be a little more complicated.

In 2004, MNST total revenues were similar to what is estimated for this year for CELH. Over the next 6 years, it had a 13% CAGR in sales and an 21% CAGR in FCF. I have created two valuation models. One according to my sales growth estimates (25% CAGR) (and applying the same FCF that MNST had at that time), and another with TIKr estimates (13% CAGR in sales and 25% CAGR in FCF). Applying a multiple of 8x price/sales, in line with the average that MNST has had during the last 10 years, we get between 9% and 17% total return CAGR, based on the current market cap. of $12.7Bn.

As an alternative and in order to include variations in COGS affected by the price of aluminum, transport freight, oil, etc., we can use a Price/Gross Profit multiple of 20x. If we assume that the gross margin will increase to 50% (48% of this quarter) compared to the current 52% of MNST (it reached a 63% margin in 2017), we obtain a CAGR of between 13% and 20% from current prices. If we apply the average multiple of MNST (15x) the returns fall to 8%-16% CAGR.

Despite the attractiveness of the returns, the most common mistake made when valuing this type of stock is overestimating the expected growth rates. The best way to avoid big falls in the share price is to buy with a margin of safety. In my opinion, the best area to buy strongly would be $120, although it can start to be attractive at $140. This would imply a 15% to 30% decrease on the share price from current levels. Since it is a volatile stock, I see it as feasible. Therefore, I rate the stock as a hold right now. I would never be short on this type of companies, especially in the long term, as we have already seen that its future seems quite bright.

Risks

A big risk is the strong competitive environment that can lead to the company not achieving the necessary brand image that Monster or Red Bull do have and that others like Bang or Rockstar have failed to achieved. Although we have already seen that consumers associate Celsius as a healthier drink than its direct rivals. In order to continue with this positive brand image, it is important that they continue investing in marketing and that they increasingly obtain more and better events and sponsorships.

Many countries' health departments consistently reassess the taxation levels imposed on sugary products. These items face the potential of increased taxes to deter consumption and generate greater tax revenue, a measure that could potentially impact the financial interests of Celsius and its stakeholders. Although Celsius products are sugar-free and there are clinical studies that support their benefits, they are still susceptible to being targeted by governments.

Conclusion

As we have been seeing throughout the article, Celsius is demonstrating perfect execution. A brand image better perceived than that of its rivals, thanks to being identified as a functional and not as an energy drink. A stellar distribution deal with PEP will help their grow and their international presence much faster. Valuation that does not differ much from Monster's, with the difference that Celsius grows much faster, but there exists the possibility of seeing a further short-term market price correction. That is why I rate the stock as a hold, but I have already mentioned the price levels at which I find the price attractive.