Green Mountain’s Results Were Strong But Here Are The Caveats

Green Mountain Coffee Roasters (NYSE:GMCR), the leader in single-cup coffee market, announced its Q4 results last week which were well ahead of the market expectations. The stock has climbed more than 25% since its earnings were announced. We believe the results signified that demand was strong but there are still uncertainties that remain which could limit the growth potential offered by the company. ^[1]

In such a scenario, we’ll be conservative about our estimates and not rely too heavily on last quarter’s results. Here are some of the caveats you should keep in mind.

a) It’s Likely To Get Worse

The latest earnings were for the fourteen weeks ending on September 29, 2012. Keurig’s patents expired in mid-September so for the majority of the quarter, the effect of patent expiration did not play a part. Two of the company’s patents expired in September which paved the way for other competitors and private labels to introduce their own, lower priced K-Cups without having any sort of an obligation to pay a royalty to Green Mountain. The initial effects could be more severe as the company might take some time to adjust to the newly increased competition.

We still estimate the number of K-cups sold by GMCR to rise helped by an increasing adoption of single cup brewers in American households and offices. However, the number of Green Mountain single cup packs sold per a Keurig brewer should decline as a higher proportion of customers switch to lower priced single cups.

Furthermore, due to intense price wars, the margins could take a beating as the company will have to introduce either lower priced products or slash the prices of existing products in order to compete against the cheaper private labels. Gross margins were already down to 32.9% for the fiscal 2012 from 34.1% in the previous year. We estimate further deterioration in the margins.

See our full analysis of GMCR here

b) Premium Brand Sales Disappoint

The disappointing news in the fourth quarter earnings was that Vue sales (brewers and packs combined) halved to $9.6 million from $20.0 million in the third quarter. The Vue brewer was introduced in the first half of 2012 and is positioned as a premium brewer used for making specialty drinks such as lattes and Americanos. The product is priced much higher than the traditional brewers. The original Keurig K-Cup brewers were generally sold at price close to its cost to boost the brewer adoption rate. The brewers themselves were not profitable.

Thus, the low adoption of Vue would imply an opportunity lost to generate profits through the sale of brewers. Also, any third party company which wants to introduce its Vue packs will have to pay royalties to Green Mountain (unlike that for K-Cups). Thus, lower adoption rates would signify an opportunity lost to generate additional royalty revenues.

We have revised out price of $29.40 for Green Mountain Coffee Roasters. The new price incorporates the latest earnings.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. GMCR 8-k [↩]