Dividend growth investors want to know if the stocks they own will continue to raise dividends not just this year or next year, but many years from now. Those investors who plan to live off dividends need to be reasonably assured that their investments will throw off a higher level of income year from now. It is why the Dividend Aristocrats, those companies with at least 25 consecutive years of dividend growth, are so popular amongst dividend growth investors.

Stocks that join this exclusive group often provide a product or service consumers demand even in a recession, have solid growth prospects, and generate the cash flow needed to fund a growing dividend.

With this in mind, this article will look at Keurig Dr. Pepper (KDP), a name held by Eminence Capital, to determine if the stock could one day join the Dividend Aristocrats.

Company Background, Growth Prospects & Dividend Analysis

In 2018, Dr. Pepper Snapple and Keurig Green Mountain completed their $20 billion merger to form Keurig Dr. Pepper. Keurig Dr. Pepper now consists of four reportable business segments Coffee Systems, Packaged Beverages, Beverage Concentrates, and Latin America Beverages. The company’s core brands include Dr. Pepper, Canada Dry, 7UP, Snapple, Bai and Keurig. Keurig Dr. Pepper has a current market capitalization of $42.5 billion and generated revenue in excess of $11 billion last fiscal year.

Keurig Dr. Pepper’s key prospect for growth is that it is the third-largest non-alcoholic beverage company in the country, trailing just the Coca-Cola Company (KO) and PepsiCo, Inc. (PEP). This gives the company a size and scale advantage that few others in its industry can replicate. The company’s carbonated beverages, like Dr. Pepper and Canada Dry, are already market leaders. Keurig Dr. Pepper is also bringing innovative new products within these brands, like Canada Dry Bold, to market.

Additionally, Keurig Dr. Pepper is now a more diversified company due to the merger. Instead of being primarily a carbonated beverage company, Keurig Dr. Pepper now has a significant amount of market share in coffee. The company estimates that its brewing systems have reach a 20% market share with a goal of achieving 30% to 50% market share in the future. This leaves more room to grow despite the sizeable market share in a fragmented business.

Coffee has become a more competitive business as new entrants among the major non-alcoholic companies occurs, but Keurig is a known and trusted brand among consumers. The cost of switching to a new brewing system could be prohibitive for consumers, which would be especially true in a recession when discretionary capital could be limited.

Keurig Dr. Pepper is well-positioned as a leader in its industry and has several avenues towards future growth. Helping to illustrate this point is that the company expects earnings-per-share to grow 14% this year. The COVID-19 pandemic has impacted business slightly, but this year’s estimate growth rate is just slightly behind last year’s 17.3% improvement in earnings-per-share. Even in a difficult operating environment, Keurig Dr. Pepper is expected to show meaningful growth.

Prior to coming together with Keurig, Dr. Pepper had raised its dividend for eight consecutive years. This isn’t long enough to qualify as a Dividend Aristocrat but does show that a commitment to a growing dividend is in the company’s DNA. That said, Keurig Dr. Pepper has paid the same exact dividend of $0.15 per share since becoming a single company.

Free cash flow has greatly improved following the merger. Prior to the merger, Dr. Pepper had $830 million of free cash flow in 2017. This surged 73% to $1.4 billion in 2018. Last year’s free cash flow totaled $2.1 billion.

At the same time, the dividend payout ratio has been reduced greatly. In 2017, the free cash flow payout ratio was a very reasonable 50%. This declined to 16% the following year before climbing to 40% in 2019. This payout ratio is very manageable and would leave room for future growth.

One headwind to dividend growth could be Keurig Dr. Pepper’s debt level. The company’s total debt jumped from $4.5 billion in 2017 to $15.6 billion following the merger. Keurig Dr. Pepper’s leverage ratio was 6x at the time of the merger. The company has paid down ~$2.5 billion of debt since becoming a single entity and the leverage ratio stands at 3.8x at the end of the most recent quarter. Keurig Dr. Pepper has a target leverage ratio of 3.5x to 3.8x by the end of this year and 3x at the end of 2021 or 2022.

Final Thoughts

Keurig Dr. Pepper has a lot of characteristics of the members of the Dividend Aristocrats. It is a key player in its industry, has room for future growth, high levels of free cash flow, and a low current payout ratio.

However, the company hasn’t raised a dividend since the merger and has stated that its primary focus is on lowering its debt levels. In our opinion, this is a very prudent decision as a lower debt level would likely be a significant benefit to the company and its shareholders.

Because of this, though, it is unlikely that Keurig Dr. Pepper will offer even minimal dividend growth until its leverage ratio declines from current levels. Those investors expecting Keurig Dr. Pepper to raise its dividend, which appears to be very safe, in the near future will most likely be disappointed.