3 Reasons to Sell KDP and 1 Stock to Buy Instead

Keurig Dr Pepper trades at $30.91 per share and has stayed right on track with the overall market, gaining 21.3% over the last six months. At the same time, the S&P 500 has returned 17.5%.

Is now the time to buy Keurig Dr Pepper, or should you be careful about including it in your portfolio? Dive into our full research report to see our analyst team's opinion, it's free.

We don't have much confidence in Keurig Dr Pepper. Here are three reasons you should be careful with KDP, plus one stock we'd rather own.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

As you can see below, Keurig Dr Pepper's margin was unchanged over the last year, showing it couldn't improve. Its free cash flow margin for the trailing 12 months was 9.9%.

Growth gives us insight into a company's long-term potential, but how capital-efficient was that growth? A company's ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).

Keurig Dr Pepper historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 5.7%, somewhat low compared to the best consumer staples companies that consistently pump out 30%+.

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

Keurig Dr Pepper's $29.98 billion of debt exceeds the $1.55 billion of cash on its balance sheet. Furthermore, its 5× net-debt-to-EBITDA ratio (based on its EBITDA of $5.41 billion over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company's rating if profitability falls. Keurig Dr Pepper could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope Keurig Dr Pepper can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Keurig Dr Pepper isn't a terrible business, but it doesn't pass our quality test. That said, the stock currently trades at 12.7× forward P/E (or $30.91 per share). This valuation multiple is fair, but we don't have much faith in the company. We're pretty confident there are more exciting stocks to buy at the moment. We'd recommend looking at the most dominant software business in the world.

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