A Speculative Idea in the Soft-Drink Space - TheStreet

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Investors would have done well to avoid soft-drink stocks during the past three years. Buying one share in each of the industry's two giants,

Coca-Cola

(KO) - Get Report

and

PepsiCo

(PEP) - Get Report

, in March 2002 would have resulted in a loss of 7.5% over this time period.

That said, one soft-drink company,

Jones Soda

(JSDA)

, has made investors some significant money. The stock appeared on our radar screen as a low-priced growth story that operates under the radar of Wall Street. Although our restrictions prevent us from adding a bulletin-board stock to the model portfolio, for those who can handle that additional risk the stock looks interesting at its recent quote of $4.73 for a small speculative position.

Despite making its home on the bulletin board and being followed by only one analyst, Jones Soda shares have gained some 1,600% from a low of 26 cents a share set about two years ago. Jones' road to success began in 1996 when it transformed itself from a beverage distribution company into a branded bottling-and-distribution play. The company has a line of flavored premium soft-drinks, which range from Green Apple to Berry Lemonade, which have allowed the company to enter the soft-drink space without going head-to-head with Coke and Pepsi.

Jones has come a long way since the days when it would put out coolers of its soda at different sporting events and in fashion stores to build its brand value. The company is now working with vendors like

Starbucks

,

Barnes & Noble

and

Target

. Its most recent deal, which was signed March 10, is with

Kroger

and gives the world's largest food retailer a three-year exclusive manufacturing agreement and a one-year exclusive distribution agreement to sell Jones' soon-to-be-introduced Frozen Soda Pops.

These relationships have led to strong sales and earnings growth. On March 3, Jones turned in impressive fourth-quarter results with sales growing 56% on a year-over-year basis to $6.4 million, and earnings coming in at break-even vs. a year-ago loss of 1 cent a share. For the full year, the company earned 6 cents a share. In addition, gross margins have been trending higher, coming in at 35.7% in the fourth quarter of 2004 vs. 32.8% for the same period in 2003.

Despite the company's strong sales growth, Wall Street remains in the dark on the story. Only one analyst follows the stock at this point, and no other analysts were even registered as listeners to the company's fourth-quarter conference call.

We believe this will change over the next 12 months. For one, Prudential estimates that Jones' current share of the premium-soda category is less than 10%. And Jones is at the genesis of its lifecycle and working off of a low sales base of $27.4 million in 2004, which should enable several years of growth above the industry average. Finally, its assorted portfolio of flavors differentiates its brand from other premium soft-drink brands like Stewart's, which is largely known for its root beer.

However, growth doesn't come cheap, and Jones doesn't hide the fact that it is going to spend more on sales and marketing in the near term to better position the company. On its fourth-quarter conference call, Jones management stated that it had made a number of new hires and increased promotional spending, and we wouldn't be surprised to see this spending continue into 2005 and weigh on the company's margins.

That said, Jones had $644,000 in cash and very little debt at the end of the third quarter, and with the company generating positive operating cash flow now, we are not concerned about its ability to fund operations over the near term. Also, Jones has a $3 million revolving credit line that it has yet to draw on.

We believe potential catalysts that could drive the stock higher include a listing on the Nasdaq; more research coverage; and continued execution that leads to new distribution agreements and increased sales. Given the company's small float of just 20 million shares and lack of institutional following, achieving any one of these could lead to a meaningful spike in the stock.

In order to qualify for listing on the Nasdaq, a stock must have an average trading price of $4 a share for 90 days. With shares currently trading above $4 a share and with volume on an upswing, we believe the company will make its way off the bulletin board in the not-too-distant future. In turn, this will increase institutional interest and analyst coverage.

We will update you readers as this story progresses, but we will remain on the sidelines given Jones' bulletin-board status.

William Gabrielski is a research associate at TheStreet.com and is accredited with a Series 7 license. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

David Peltier is a research associate at TheStreet.com In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. They welcome your feedback and invite you to send your comments to

stocksunderten@thestreet.com.