Soda Maker Should Benefit From Nationwide Rollout

INVESTORS HAVE BEEN bubbling over with enthusiasm for Jones Soda (JSDA), a tiny company with a portfolio of premium branded soft drinks that has seen its shares erupt in the past year. That run-up has made Jones's valuation expand to levels that would give most investors gas, but the company is in the midst of a big-time national rollout of canned soda, and in the soda business, cans are king.

Jones, with it's roughly $300 million market cap and close to $40 million in annual sales, has built a fanatically loyal customer base since 1995, with brands such as Green Apple soda, Cherry White organic tea and WhoopAss energy drink. The Seattle company sells its bottled products at retailers such as Starbucks (SBUX), Panera Bread (PNRA) and Barnes & Noble (BKS). As for the cans, that soda was only available at Target (TGT).

But Jones's two-year contract selling cans exclusively at Target expired Dec. 31. In anticipation of that, last September the company inked a distribution deal with National Beverage (FIZ) — an agreement intended to transform Jones into a truly national player. That move, along with the company's announcement at a January investment conference that it had signed up 25% of the retailer canned-soda market (up from Target's 2% share), got the stock fizzing. Investors saw their stakes pop 89% in the last year to $12.31 a share as of Wednesday's close. By comparison, the small-cap benchmark Russell 2000 index gained 9% over the same period.

Eschewing the industry-standard sweetener of high-fructose corn syrup to go with its hip, all-natural image, in January Jones rolled out its 12-ounce cans of Jones Pure Cane soda with the tag line, "Corn is for cars, sugar is for soda." But there's much more to the story than a cute line. "There's about a $70 billion market for soda out there, and the vast majority of it is sold in cans," says James Maher, an analyst with ThinkEquity Partners, the San Francisco investment bank.

Jones will report fourth-quarter earnings on March 8, and of more interest, reveal the list of retailers the company has signed up to sell its cans. Investor anticipation of which retail names will be carrying the soda has given the quarterly report an "Oscar-esque" feel, says Maher. And sure, it's probably hard for investors not to pray, "Let there be Wal-Mart."

And perhaps there will be Wal-Mart (WMT), giving the stock a further boost. Perhaps there will be some disappointment, creating a buying opportunity. Either way it shouldn't matter much; observers say Jones is a long-term play, whether you're comfortable with the valuation or not. And by most traditional measures, the stock looks filthy rich. Its forward price/earnings multiple stands at around 95 and its price-to-earnings growth, or PEG, ratio stands at about 3.2, or more than twice that of the S&P 500. Alton Stump, an analyst with Longbow Research, an independent research firm based in, yes, Independence, Ohio, says he sees growth opportunities aplenty, but rates shares at Neutral on valuation.

But there's a compelling case to be made for the business fundamentals and quality of management that observers say trump the seemingly gaseous valuation. "We've always said this is a long-term opportunity on a company that's evolving and changing its business model," says Nicole Miller Regan, an analyst with Piper Jaffray, the Minneapolis investment bank. She has an Outperform rating on the stock. "It's a high-quality, high-growth opportunity and it's never been cheap. It may never look exactly 'cheap,' and that's for a reason. You have to look beyond the traditional multiples for valuation and consider the long-term opportunity."

The deal with National Beverage for canned soda distribution is the crux of the long-term opportunity. For one thing, Jones is able to add capacity without having to build it. It also affords much higher margin opportunities than bottling soda in-house. Bottles carry a gross margin of about 35%; cans closer to 45%. "The average selling price per case and the margins they give to retailers are substantially higher than the national and private-label brands," says Peter Niedland, lead manager of the NS Small Cap Growth fund (NSIPX), which got into the stock in the $8-to-$9 range. "By owning the stock we clearly think there's upside left in the story."

Going from the $500 million niche premium-soda market to the $70 billion canned carbonated beverage market naturally creates tremendous top-line potential. Perhaps more important, Jones sells at a higher price point than Coca-Cola (KO), Pepsi (PEP) or store brands, and that's something retailers love. "Coke and Pepsi, generally one or the other, has a sale product at any time you go into the supermarket," says Maher. "They are heavily, heavily promotional. So if you go with the Joneses, they are much less promotional, and for the same square footage retailers get much larger gross margin dollars."

As for management, Peter Van Stolk, founder, chairman and chief executive, gets praise for his youthful dynamism — he's 43 — as does the way Jones has set itself up for future growth. "I like the fact that they've got guys like Scott Bedbury on the board, who's the former head of marketing at Starbucks and advertising at Nike (NKE), where he launched the 'Just Do It' campaign," says NS Small Cap Growth's Niedland. "I feel like the company has positioned itself from an operational standpoint to surprise Wall Street in a positive direction. And they've built a management team and infrastructure since they decided to go into this can market that will allow them to really accelerate growth from here."

Some investors are betting that Jones will be the next Hansen Natural (HANS) — the best-performing stock of the past 10 years, according to The Wall Street Journal. But the parallels aren't really that close, in some ways to Jones's advantage. Hansen had huge, explosive growth on essentially one energy drink brand, Monster Energy, Longbow's Stump points out. The Jones story is predicated on its wide portfolio of premium sodas.

"Jones Soda is in a category of its own," says Piper Jaffray's Regan. "First, it truly is a lifestyle brand. Two, it's a portfolio of branded products. That's really important. Jones Soda won't be a win on one thing. Jones Soda's a win because it has an entire portfolio of branded products. And that's what makes it a great long-term investment opportunity."