The soda-producing Warren Buffett mainstay has been performing beautifully lately. First quarter 2007 results were just released, with earnings beating what Wall Street had modeled and sales outdoing first quarter of last year.

Give the credit to new products, like Coke Zero, and international markets.

But there’s a black cloud hanging over Coke… It’s declining soda sales in North America.

In fact, 1Q07 brought a 3% drop in soda revenue in this key market, and fingers are being pointed at Americans’ tastes running toward healthier alternatives like bottled waters, drinks with vitamins and traditional hot beverages.

Coke has warned that sales for the rest of this year will probably not reflect any major turnaround just yet in North America.

But for small-cap investors, there are ways to play the soda industry, and ways to profit from the companies that are giving Coke some headaches…

So-called “gourmet soda” growth is the story here. Look no further than relative newcomers Jones Soda (JSDA: NASDAQ) and Hansen Natural (HANS: NASDAQ). The former is a small-cap, the latter is a bit bigger with a $3.5 billion market cap.

A few years ago, you could only buy Jones Soda products at record stores, surf shops and tattoo parlors. Now, this maker of so-called “alternative” sodas with pure cane sugar has bottles in Starbucks, Target and 7-Eleven. The packaging is pretty distinctive — customers send in personal photos to Jones, and the best get accepted on their sodas’ labels.

Hansen markets itself as a natural soda maker, and also markets bottled smoothies and various energy drinks. The company dates back to the 1930s when the Hansen family was a juice supplier to the Hollywood film industry.

What these two companies have in common financially, though, is tremendous top- and bottom-line growth. Jones has averaged 20% revenue growth for the past seven years, with earnings making the turn to the plus side in 2003, and posting 254% net income growth just last year. All the while, Jones has been consistently expanding margins as well. Bigger brother Hansen has been even more impressive. Sales have grown on average 31% over the last seven years, with last year posting a 94% jump. But that wouldn’t be impressive without a jump in profitability…and Hansen hasn’t disappointed. Earnings have grown an average 53% for the last seven years.

The Beverage Marketing Corporation has the carbonated soda pop business pegged at $65.9 billion in total annual sales for last year. But traditional soda growth has been spotty and lackluster for much of this decade.

While Jones and Hansen are called “sodas,” and are definitely competing for Coke and Pepsi consumer dollars, industry insiders refer to these niche drink companies as New Age beverages. And this segment hasn’t been sliding in recent years. The most recent data we have shows that this is an almost $17 billion industry at the wholesale level and growing.

Investors have noticed, too.

Jones is up 103% in just the last two months alone. Hansen is up 281% since June 2005.

Small-cap investors should look for the beverage company stocks that have a great product, but aren’t profitable at the moment, and don’t have their distribution quite in place. When the stars finally align, a lot of the upside will already be gone.

What we’re working on right now within the Small-Cap Group at Agora Financial is a miniscule, off-the-radar gem of an alternative drink company, which has not yet turned the corner to making money every year… It has got an unlikely founder who not only produces a one-of-a-kind healthy soda, but has also gathered up the cash for his company to flourish through grit, determination and a pretty good understanding of the public investment game…

Until next time,
Craig
April 20, 2007

Small-Cap Soda Companies was originally featured in the Penny Sleuth.