Bottled Water to Hold the Line?

Analyst changes tune on predicted price increase in 2006

NEW YORK -- More than two months after predicting bottled water would likely see a price increase led by Nestle Waters in early 2006, beverage analyst Bill Pecoriello of Morgan Stanley, New York, is whistling a different tune following a beverage conference this week.

We thought there was a chance the industry would take prices up in [the first quarter of] 2006 due to higher cost resin and other cost pressures, Pecoriello wrote in a recently released report. [But] Nestle indicated [on December 12] it hasn't received any indication that either Pepsi or [image-nocss] Coke plans to follow its water price increase in early 2006.

Pecoriello also said that the predicted price increase likely would have been temporary, dropping after Memorial Day when the hot weather was lapped and resin prices eased. Pecoriello initially noted the likely price increase in an October 3 report, as reported in CSP Daily News.

In this week's note, Pecoriello repeated the results of Morgan Stanley research that shows only 20% of consumers are loyal to only one water brand, while 40% of consumers buy whatever is cheapest.

Beverage executives should not confuse low-price-driven volume gains or high-cost exclusive contracts with club stores with consumers' loyalty to their brand, he wrote. The best predictor of market-share moves in the water segment continues to be relative price moves.

As such, Pecoriello also noted, We estimate Coke and PepsiCo make close to zero margins in bottled water, given the marketing/promotional spend back. While their bottlers (PBG, CCE) do make positive margin, those margins have been shrinking, with profit growth trailing volume growth.

Finally, the long-time beverage analyst added that bottled-water growth has been a major contributor to the CSD (carbonated soft drink) slowdown with about 64% of incremental water volume coming out of CSDs.

Overall, Pecoriello noted the implications of the change in the pricing outlook: With the cost environment expected to still be tough in [the first half of] 2006, the inability of the industry to pass through cost increases in bottled water is a negative for all U.S. soft-drink players as the category continues to drive 50%+ of incremental LRB (liquid refreshment beverage) volume growth. The ability of the industry to still pass through cost increases on CSDs and to try to innovate successfully in healthier non-carb beverages will be key for the go-forward outlook.

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