Celsius Holdings (CELH, Financial) experienced a significant boom from 2023 to the first quarter of 2024, driven by its strategic partnership with PepsiCo (PEP, Financial), poised to accelerate Celsius's market penetration. This collaboration granted PepsiCo a minority stake in Celsius and established it as the company's preferred global distribution partner. Leveraging PepsiCo's extensive network, Celsius expanded its market reach, leading to explosive sales growth that drove its stock to new highs.

When the partnership began, PepsiCo needed to build up a sufficient inventory of Celsius products to supply its vast distribution network. This led to a substantial initial purchase from Celsius, boosting sales during the period and driving the stock price upward. Under this arrangement, PepsiCo purchases products directly from Celsius, which marks the point of revenue recognition for Celsius. This means that once PepsiCo takes ownership of the inventory, the sale is complete from Celsius's perspective, and the associated revenue is recorded on Celsius's financial statements.

With that being said, Celsius revenue skyrocketed, however, Pepsi couldn't sell Celsius as expected. As PepsiCo adjusted its inventory levels to align with actual consumer demand, these changes introduced short-term disruptions. These adjustments have weighed heavily on Celsius's year-over-year (YoY) comparisons, presenting a challenging period for the company.

In this article, I explore the key challenges facing Celsius Holdings, including its reliance on discounts, tax-loss harvesting pressures, and the uncertainties around its competitive moat, while also highlighting the opportunities presented by its partnership with PepsiCo and international expansion.

A Health-Conscious Offering

Before its partnership with PepsiCo, Celsius had already carved out a unique niche in the competitive energy drink market. Unlike traditional energy drinks loaded with sugars and artificial ingredients, the brand focuses on health-conscious consumers by offering sugar-free, vegan-friendly, positioning it to resonate with a growing demographic seeking healthier beverage options.

Source: Celsius Investor Presentation

Celsius's commitment to natural ingredients and functional benefits has differentiated it from competitors and helped drive market share growth. As of May 2024, Celsius's market share peaked at 11.5% in the U.S. energy drink market. However, recent data indicates a slight decline, reflecting some loss of momentum. Despite these challenges, Celsius remains the third-largest energy drink brand in the U.S., behind only Red Bull and Monster (MNST, Financial).

Source: Celsius Investor Presentation

The brand's appeal extends beyond North America, with ongoing global expansion efforts in Europe, Asia and other regions. During Q3 2024, Celsius entered six new countries, driving international revenue growth of over 35% YoY. Despite this success, international revenue still represents only 7% of total revenue, highlighting significant opportunities for further expansion. International growth could prove a double-edged sword if the company struggles to build brand loyalty outside of North America.

Financials

Celsius has reported earnings, missing on both the top and bottom lines. Total revenue in Q3 2024 decreased by 31% to $265.7 million, compared to $384.8 million the previous year, missing analysts expectations of $269 million. Earlier in the year, Celsius had reported a 37% year-over-year revenue increase in Q1 to $355.7 million but still fell short of the $390.4 million analysts had anticipated, primarily due to PepsiCo's inventory adjustments.

The third quarter demonstrated challenging. Net income declined by 92% YoY to $6.4 million from $83.9 million, with operating margins turning negative by $3 million. The company's net income was only positive because of $11 million in interest income generated from its significant cash reserves. Despite these pressures, Celsius reported free cash flow of $9 million and maintained a strong balance sheet with $904 million in cash and equivalents and no long-term debt.

Looking ahead, analysts expect Q4 revenue of $338 million, a 12% decline YoY. The CFO has acknowledged the risk of slower-than-expected sell-through rates, which could create up to $15 million of additional pressure on Q4 revenue.

Vertical Integration Acquisition

Despite the pressure on turnover, Celsius put its cash to work and on November 1, 2024, Celsius acquired Big Beverages Contract Manufacturing for $75 million in cash, avoiding shareholder dilution. Big Beverages has been a long-standing co-packing partner hence I would expect a smooth transaction, will add a 170,000-square-foot manufacturing and warehouse facility to Celsius's operations. This acquisition enhances Celsius's ability to control its supply chain while supporting both short- and long-term growth.

By integrating Big Beverages, Celsius expects to achieve input cost savings and improved operating leverage in both the short and long term. The acquisition strengthens the company's competitive edge by restructuring its supply chain, reducing lead times, and ensuring product availability in key markets. Additionally, localized production capabilities could lower logistical expenses and facilitate more efficient international expansion. This vertical integration also enables Celsius to accelerate product innovation.

My two cents about Celsius

Competing with industry giants like Red Bull and Monster is challenging, but Celsius has established itself as a health-conscious alternative with sugar-free and vegan products. The company has steadily gained market share increasing shelf space over the past few years and sees significant opportunities for international expansion. The sponsorships, such as being the main sponsoring in the Jake Paul vs. Mike Tyson fight, underscore the brand's investment efforts to push brand awareness.

However, I remain hesitant to invest in Celsius for two key reasons:

1. Proving the moat

One of the reasons I haven't invested in Celsius is that I still question its moat. In a sector with low barriers to entry, the brand itself is often the primary moat. For me, an indicator of brand strength is whether a company can sell its products without lowering prices, reflected in its gross profit. When a brand needs heavy discounts to drive sales, it raises questions about customer loyalty. Celsius has gained market share, but at what cost? The declining gross margins this quarter concern me because, in the energy drink market, brand strength is one of the few real advantages.

For example, Monster Beverage is a prime example of this dynamic, consistently growing revenue and maintaining healthy margins without relying on significant price cuts. (Celsius's recent margin growth was significantly supported by PepsiCo's initial inventory buildup. However, this is unlikely to be the norm moving forward.)

Source: Koyfin

By contrast, if Celsius's growth is largely driven by discounts, I wonder how sustainable it really is. On the earnings call, Celsius's management acknowledged that discounts remain a key strategy, even in established markets. This reliance on price incentives raises concerns about how well the brand will retain its customer base once discounts fade.

Therefore, the big question for me is whether Celsius's market share increase reflects genuine customer loyalty or just the impact of discounts. I understand that Celsius is in an early growth phase, especially with its international expansion, and these discounts might be part of building brand awareness. But the real test will be whether customers keep coming back once the discounts are gone.

2. The tax-loss harvesting

Second, Celsius has faced a lot of selling pressure in recent months, with its stock reaching recurrent 52-week lows. While much of the focus has been on inventory challenges and earnings volatility, I believe tax-loss harvesting may also be playing a major role in the current sell-off. This strategy allows investors to sell losing positions to realize capital losses, which can then be used to offset gains from other investments, reducing overall tax liability. For investors holding Celsius shares at higher cost bases, the recent declines have presented an opportunity to lock in these losses before the fiscal year ends.

This dynamic is particularly relevant in the case of Celsius, as many investors likely accumulated shares during the stock's prior highs amid its rapid growth. The stock's recent struggles have made it a candidate for end-of-year tax planning. By selling now, investors can “clean the slate” of losing positions and potentially repurchase the stock after the mandatory 30-day wash-sale period, allowing them to reestablish exposure in January while capturing the tax benefits. Once the wash-sale window closes and market sentiment normalizes, Celsius could experience renewed buying interest from investors seeking to capitalize on its growth potential.

Such selling pressure, driven by tax optimization rather than changes in the company's fundamentals, often creates temporary headwinds for stock performance. However, this period of sharp sell-off can present opportunities for long-term investors. With valuation metrics such as price-to-sales at 4.4x and forward price-to-earnings at 30x, well below historical averages, Celsius could become more appealing to long-term investors. These levels, while still high on an absolute basis, are considerably more attractive relative to the company's past trading ranges and its long-term growth prospects.

However, these valuation levels might be low for a reason. Until Celsius proves that it can resolve its inventory challenges, sustain margin improvements, and reignite revenue growth, caution remains warranted.

Conclusion

Celsius has been fixing issues related to PepsiCo's inventory and investing heavily in expansion and brand awareness. While these efforts position the company for future growth, the current challenges around proving its moat and maintaining sustainable profitability keep me on the sidelines. I'll continue monitoring Celsius to see whether it can stabilize margins, grow without reliance on discounts, and establish itself as a truly dominant player in the energy drink market.