There are a few reasons why I like Monster Beverage Corporation's (MNST, Financial) thesis. The company has shown impressive revenue growth in recent years, executing a brilliant marketing and similar strategy, generating awareness, increasing market share, and more. Another reason is that the company is in a very reliable and promising segment, with the consumption of energy drinks on the rise. In addition, this good execution translates into strong cash generation and, in the end, is converted into shareholder returns via a significant amount of buybacks.

Despite this, there are two main reasons why I believe Monster stocks are not so compelling at the moment. The first is their market momentum, with a market share that is slipping due to the threat of new competitors, as well as growth that is showing signs of slowing. The second is that even with these uncertainties emerging, the valuation hasn't dropped too much, remaining at a high level and already pricing in the continued revenue advances that make Monster a compounder.

Monster's Formula for Success

Monster's thesis begins to show the quality in its governance. In 2014, Coca-Cola Co. (KO, Financial) bought 16.7% of the company and is currently still a significant shareholder with a stake of around 20%. This stake is strategic for both companies, which take advantage of it through partnerships, expertise, and especially Coca-Cola's broad distribution power, which is available in most parts of the world, as illustrated in the image below.

Source: Monster IR

In addition to geographic diversification, Monster also owns other beverage brands, such as Reign, Nos, Burn, and many others. Monster Energy Drink itself has also expanded into other flavors over the years and has also adopted marketing campaigns that have proved to be very assertive. The company has bet on different strategies in recent years, with promotions related to UFC, Gaming (with partnerships with Call of Duty), Zero Sugar, as well as sponsoring different sports and even e-sports.

In the end, all this good work is converted into net revenue. The graph below illustrates this consistent progress and also that the bar remains high, with the market expecting the company to continue to make considerable progress.

Source: GuruFocus

Despite the recent falls in margins - which the third quarter explains by the increase in payroll expenses, sponsorship, and endorsement costs, as well as other factors such as the increased inventory - the net income margin remained at a level that allowed for the evolution of shareholder value generation. A solid net income margin, together with continued revenue expansion and some buybacks, led to a massive increase in Free Cash Flow per share.

Source: GuruFocus

With this good track record of execution over time and a proven business model that has built moats around distribution, brand recognition, and the like, Monster looks to be one of the key companies positioned to continue capturing growth in this market. According to Grand View Research, the global energy drinks market is expected to grow at a CAGR of almost 8% until 2030.

In other words, expecting Monster's value generation to grow at a CAGR above this in the same period is reasonable, since in addition to normal market growth, the company can recover market share, carry out price increases, and efficiency optimizations that improve margin and consequently EPS/Free Cash Flow, not to mention buybacks that increase per share indicators.

Reason 1: Market Shifts Add Complexity to Monster's Growth

Monster has already become a very well-established brand in the world of energy drinks, coming very close and even overtaking Red Bull in a few months, when market share is measured by unit and a little further away when measured in U.S. dollar share.

In my opinion, the biggest threat is not even Red Bull (although in Q3 the brand showed an excellent performance and is still by far one of the leading brands). In the graph below it is clear that there has been a certain stagnation in Monster's market share since 2022, with some falls from mid-April 2023, and a strong loss of Bang. This factor highlights the dynamic momentum of the market, which has migrated to Celsius Holdings Inc. (CELH, Financial), which has managed to build a strong brand among fitness and health customers.

As mentioned in Q3, this trend continued, with Monster's share declining from 29.7% to 28.7%. As a reflection of this, sales of the Monster brand declined by 1.6% in the same period, but revenue increased by 1.3%, reaching $1.88 billion.

This more complex moment in the market has given us some insights. I believe that in the short term, it won't be easy to resume revenue growth above double digits, a level that has not been uncommon in recent years. In addition, it shows that even though Monster is consolidated and has significant moats, it can still suffer from economic headwinds and new entrants.

I don't believe that Celsius or any other brand will completely disrupt Monster's growth, but it does add a level of uncertainty to the projections, i.e. instead of projecting that in the coming years, the company will maintain a revenue CAGR of ~10%, it's more reasonable to be extra cautious and believe that in the short and medium term, this may be slightly lower due to these challenges.

On the other hand, I think it also shows how much quality the company has. Even with the challenges of competition and macroeconomic challenges in some countries, the company managed to maintain its position as the leading energy drink brand in value in Argentina, Brazil, and Chile; increasing its sales at a small pace even with a drop in sales of its main brand; and even increase its gross margin.

In other words, in the medium and long term Monster remains well-positioned to grow and be a compounder, but the degree of uncertainty has increased

Reason 2: Quality Persists, but Valuation Demands Caution

I believe that the quality of the company and its long-term prospects outweigh the challenges faced in the short term, but even so, the ideal is to use slightly more conservative assumptions to ensure a better margin of safety.

Monster's current multiples continue to reward both the robustness of the company's moats and the good prospects for the financials. The price-to-OFC is around 29x, a level very similar to the price-to-earnings forward which is 28x. Both indicators are not as overvalued as they appear to be at first glance, since they are close to and even below the historical mean.

Source: GuruFocus

Forecasting Monster's earnings for the next few years with reasonable assumptions also shows that the multiples are not so rich. Using market estimates for 2024 and 2025, and adopting a higher degree of conservatism, it is possible to arrive at an earnings yield of 4% (P/E of ~24x) in 2027. For a company like Monster, a scenario where revenue grows by an average of 7% by 2030 and its net margin returns to something close to 23.3% seems like a base scenario, and a p/e below 25x from 2027 already seems interesting.

Source: Author (Kênio Fontes); GuruFocus

However, this scenario is not so compelling for the shareholder. Waiting years to have a shareholder yield slightly above 10-year treasuries is not ideal. However, in a more optimistic scenario, in which the company resumes revenue growth of ~12% from 2027 and also increases its net income margin to 24.3%, the stock is already more appealing. This scenario, which although optimistic is not that difficult to achieve, already implies a P/E of 15x in 2030, equivalent to an earnings yield of 6.5% and possibly a substantial increase in the value of the stock by then, since its average multiple is closer to 30x than 20x.

Source: Author (Kênio Fontes); GuruFocus

Believing in the most optimistic scenario described above means believing that net income will advance by around 13.5% in the period from 2026 to 2030. Applying this to a DCF model as a proxy for free cash flow, along with a discount rate of 8% and a growth rate of 10% for the terminal stage, we still find a fair value of $47.3 for Monster stocks.

Source: GuruFocus

This scenario is completely plausible, and could still be surprising since buybacks could cause EPS to exceed this growth if revenue advances to such levels, but it demonstrates a lack of margin of safety in current prices.

The Bottom Line

Putting all the factors together, I believe that the valuation is not so attractive right now, there are challenges that could slow down revenue growth a little and the company needs to maintain this high growth for the valuation to make sense

Even so, considering the possible positive surprises and the premium needed to reflect the quality of the company, I think it's worth keeping Monster on the radar since the current prices aren't so disconnected and it could eventually open up a greater margin of safety to justify adding exposure to the thesis.