Green Mountain Q4 Earnings: Margins Will Rise But K-Cup Volume Under Spotlight

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GMCR: Keurig Green Mountain logo
GMCR
Keurig Green Mountain

Green Mountain Coffee Roasters (NASDAQ:GMCR) is scheduled to announce its fourth quarter earnings on November 20. For fiscal 2013, the company expects net income of $3.19 to $3.24 per share on revenue growth of 13% to 14%. However, shares of the company have declined 30% in the last three months as a number of high profile hedge fund managers including Whitney Tilson and David Einhorn maintained their short position in the company. Here are some of the things to watch out for in the upcoming earnings.

See our full analysis of GMCR here

Margins Set To Rise

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The company has registered strong profits in the recent quarters on the back of low coffee prices. In fact, the gross margins widened 720 basis points to 42.1% in the previous quarter. Arabica coffee prices have been subdued for quite some time now and were recently trading near four and a half year lows. [1] Since Green Mountain’s biggest expense is on acquiring coffee, the company is likely to record strong profits as long as the coffee prices remain suppressed. Weak economic environment in Europe, which is the biggest consumer of arabica, combined with a record glut in Brazil are pushing down the coffee prices.

Thus, expect the company’s gross margins to expand on a year-over-year basis even though there could be some deterioration on a sequential basis. For the full year, we expect Green Mountain’s gross margins to improve more than 300 basis points in 2013.

Watch Out For K-Cup Volumes

Hedge fund managers maintain that the company’s growth is likely to slow down now that Green Mountain’s key patents have expired. Green Mountain has so far risen to the challenge pretty well. In the last three quarters, the company’s K-Cup volumes have risen at a rate of 26%, 26% and 21% (year-over-year) respectively.

But fund managers argue that it will take some time before the private labels make their presence felt on the supermarket shelves and eventually cause a dent on Green Mountain’s income statement. Two of the company’s patents expired in September last year, which opened the doors for private labels to introduce their own K-Cups, without having any obligation to pay royalty to the company.

Investors will be keenly eyeing the K-Cup volume growth figures. A recent report suggested that Green Mountain was losing market in the single serve coffee segment. [2] Since the K-Cups account for a disproportionate amount of the company’s profits, any drag on the their volumes can adversely affect the company’s profits.

This is the prime reason why there is an air of pessimism about the company at the moment. Green Mountain hardly makes any money through the sale of its Keurig brewers since the company often sells them at cost price in order to boost their adoption rates.

It will also be interesting to see how this quarter pans out in terms of brewer volumes. Keurig brewer’s volumes remained flat on a year-over-year basis in the previous quarter. Prior to that quarter, the company’s brewer volumes had declined 9%. A continual weakness in its volume doesn’t bode well for the long term prospects of the company. After all, you could argue that the higher the number of brewers sold, the higher the number of coffee pods that are likely to be sold.

We have a $71 price estimate for Green Mountain Coffee Roasters, which is about 15% lower than the current market price.

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Notes:
  1. Brazil May Prop Up Coffee Prices, November 14, 2013, wsj.com []
  2. OTR Global: Green Mountain Coffee Losing K-Cup ShareRead, November 13, 2013, thestockmarketwatch.com []