Keurig Green Mountain’s Earnings Preview: Recent Distribution Deals To Boost Brewer and Portion Pack Sales

Keurig Green Mountain (NASDAQ:GMCR) is scheduled to announce its third fiscal quarter earnings on August 6, 2014. ((Keurig Green Mountain Q3 2014: webcast)) The Vermont-based coffee company expects non-GAAP earnings per diluted share for the third quarter to be in the range of $0.83 to $0.88.  The company delivered impressive results in its second quarter, driven by a combination of strong top-line growth and operating leverage.

In the second quarter, Keurig’s net sales grew 10% year-over-year (y-o-y) to $ 1.1 billion, attributed to a 29% increase due to brewer sales volume. ^[1] Portion packs-related net sales rose 13% y-o-y driven by increased volume and increased portion pack product mix, partially offset by the net price realization of packs. ^[2] Moreover, brewery and accessory net sales increased 9%, driven by increased brewer sales volume. As a result, gross profit increased 10%, which led to a 20 basis points improvement in gross margins.

See our full analysis of GMCR here

Over the last few years, the company has signed several distribution agreements with major brands such as Dunkin’ Brands (NASDAQ: DNKN), Peet’s Coffee and Starbucks Corporation (NASDAQ:SBUX) to provide its consumers with high quality premium coffee at nominal rates, with a target to expand the customer base. Keurig has increased its pace in partnering with major brands after its patents of K-Cups expired in September 2012.

In the third quarter, Keurig joined hands with some of the big brands in the beverage and food industry such as Coca-Cola, Subway, Nestlé (SIX: NESN), Café Bustelo and Harris Teeter, which might provide a boost to its portion packs and brewer sales. Moreover, some of these partnerships may provide an additional boost to initial sales of the new brewers to be released by the company. Keurig’s new and improved brewer- Keurig 2.0 is scheduled to be launched in the fall this year, along with its cold beverage brewer- Keurig Cold.

New Partnerships Might Boost Keurig’s Top-line Growth

• Partnership With Coca-Cola To Boost Initial Sales Of Keurig Cold

In May 2014, the beverage giant, Coca-Cola became the largest shareholder of Keurig Green Mountain, after it announced raising its stake in the company to 16%. ^[3] Coca-Cola has already bought 2.8 million of those shares, and has plans to buy the remaining 6.5 million within the next nine months. Basically, both the companies entered into a joint venture, where they would work together towards the development of Keurig Cold- the cold beverage brewer. (See: Coca-Cola-Keurig Green Mountain Deal: A Win-Win Situation For Both)

Keurig Cold will be designed to dispense single servings ranging from Carbonated Soft Drinks (CSD) to non-carbonated beverages like juice drinks and iced teas. Due to increasing health concerns, consumers are shifting from carbonated drinks towards alternatives like iced coffee, juices and sports drinks. However, according to our estimates, CSDs still constitute about 43% of the 30 billion gallon liquid refreshment beverage (LRB) industry in the U.S., forming the largest segment. ^[4] Keurig Cold provides an added platform for Coca-Cola to reach its large CSD consumer base, apart from other beverage products, which are high in demand lately. This means the consumption rates of avid customers could grow, come the Keurig Cold machine.

Keurig Cold will provide its users the convenience of at-home carbonation technology and the ease of carrying compact flavor sachets, rather than the bulky PET bottles from retail stores. GMCR has gained goodwill among consumers, due to the success of its products in the U.S. Additionally, its partnership with Coca-Cola, the world’s third most valuable brand, could bolster demand for the Keurig Cold Beverage system and related accessories. This has acted as a useful marketing tool, which is likely to boost sales during the initial period.

Currently, we estimate the total number of Keurig Cold brewers sold by the end of 2014 to be around 0.4 million, which could reach 1.4 million in 2015.

• Partnership With Subway To Boost Brewer Volumes

In the month of June, Keurig Green Mountain announced its partnership with the restaurant chain-Subway to bring Keurig’s single-serve brewers to almost all of the Subway chains in the U.S. and Canada. With coffee becoming the core product for breakfast menu, Subway is looking to provide its customers with high quality premium coffee at nominal rates and at much more convenience.

With Subway being the largest single-brand restaurant chain in terms of number of restaurants world-wide (42,000 stores in 107 countries), this deal might prove to be a blockbuster move for Keurig Green Mountain. The Keurig K150 brewer might expand the Subway’s hot beverage menu, providing freshly brewed and high quality coffee to its customers. This will help Keurig brewer systems to reach out to more customers, giving a boost to brewer and portion packs’ volume growth, which might subsequently translate to improved revenue growth. According to our estimates, K-Cup portion packs account for 78% of the company’s total valuation, as it contributed 74% to the company’s gross profits in 2013. (See: Keurig Green Mountain’s Partnership With Subway To Boost Volumes Of Brewers and K-Cups)

On its website, Subway reports that it sells 2,800 sandwiches and salads per minute worldwide. ^[5] This accounts for nearly 35,000 sandwiches and salads per restaurant sold annually. In developed nations such as the U.S. and Canada, Subway’s combined largest market, the estimate may rise to 38,000 sandwiches and salads per restaurant annually. There are nearly 30,000 stores in these two nations combined. Taking a conservative estimate that Keurig brewers would be available in minimum 80% of these restaurants and that 1 coffee is sold per 20 sandwiches (5% of the sandwich sales), Subway would sell 45 million coffee cups annually. This would translate to net K-Cup annual sales of around $15 million for Keurig Green Mountain as one K-Cup costs $0.33, according to our estimates. If we consider, that 1 coffee is sold per 10 sandwiches, the net sales’ estimate may rise up to $30 million. In any case, the company expects a boost in sales of K-Cups when this move go into effect, due to incremental coffee sales at the Subway restaurants. Overall, the company expects a boost in sales of K-Cups when this move goes into effect, due to incremental coffee sales at the Subway restaurants.

Moreover, with Subway restaurants installing Keurig’s brewers, the company expects the brewer sales to rise. If Keurig coffee proves to be a success at Subway restaurants, stores in well developed locations might install more number of brewers per restaurant.

• Partnership With Nestle To Boost Net Sales

Keurig Green Mountain announced a multi-year deal with the U.S. division of Nestlé, Nestlé USA on July 1, to bring Nestlé’s branded coffee with creamer to its customers. Although the deal took place after the third quarter and would not play any role in Q3 performance of the company, it still would play a vital role in the coming quarters. Nestlé is the first brand to offer 2 in 1 K-Cup pack for hot coffee, combining high quality roast and ground coffee with branded creamer. The Nestlé Coffee-mate K-Cups will be available at Keurig’s online stores in fall of 2014 and in retail stores in spring of 2015. (See: Keurig-Nestlé Deal: Creamer Added K-Cups To Boost Net Sales)

With this deal, the company expects to reach out to its U.S. customers and provide them with Nestlé’s Coffee-mate non-dairy creamer as an added ingredient in single-serve coffee packs for instant brewing. According to the company, the partnership might bring new innovation and flavor to the Keurig product line, while offering its customers an easy access to their daily coffee without compromising on the taste.

According to Rob Case, President of the Nestlé Beverage Division, Nestlé USA, 27% of all Keurig users prefer Coffee-mate to cream their coffee. ^[6] Taking a conservative estimate that an added creamer pack in K-Cups would force the company to increase its price by 8-10%, then one Nestlé creamer added K-cup would cost around $0.38. These 27% customers would prefer these creamer-added K-Cups rather than buying a separate powdered or liquid creamer container from retail stores. If we take an estimate that 20% of the remaining customers also start using the new creamer added K-Cups, it would result to around 40% of the total Keurig users buying the new product. According to our estimate, company might manage to sell around 11,000 K-cups worldwide in 2014 and if 40% of these portion-packs cost $0.03 more, company might earn additional revenue of $132 million from the creamer added K-Cup, which would account for 3% in revenue growth due to K-cup portion packs next year.

Additionally, Keurig Green Mountain has joined hands with Harris Teeter- the renowned supermarket chain in the U.S. and Café Bustelo- a coffee brand owned by J.M Smucker. This would provide additional revenue growth to the company in the coming few months.

Favorable Commodity Environment To Help Maintain Margins

The price of coffee beans surged almost 100% from a level of 106 cents per pound to around 220 cents in mid April, due to tight supply as a result of prolonged drought in Brazil, followed by recent floods.((Coffee futures, July contract, 2014)) It could be driven higher by the end of this year due to increasing demand for premium coffee beans. The spike is large enough to make a visible difference in the bottom line performance of the company. However, according to GMCR’s latest annual report ^[7], the company bought 216 million pounds of coffee and it is hedged for the fiscal year 2014. The company is somehow managing to insulate itself from rising coffee prices and protecting its gross margins from declining. We might expect better margin growth in the third quarter report.

However, if the coffee prices kept on rising, the company may take defensive measures by raising the prices of its K-Cups. According to our estimates , the average price of a K-Cup portion pack is around 33 cents and we expect it to touch 35 cents by the end of 2014. A rise in the prices of K-Cups to offset increased coffee costs will provide stability to margins.

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1. GMCR 10-Q, Second fiscal quarter, May 7, 2014 [↩]
2. Keurig Green Mountain (GMCR) CEO Brian Kelley on Q2 2014 Results- Earnings Call Transcript [↩]
3. SEC filing, May 8th, 2014 [↩]
4. U.S LRB Market, www.beveragemarketing.com [↩]
5. Subway FAQ’s [↩]
6. Keurig’s K-Cups to feature coffee and creamer [↩]
7. GMRC, 10-k, September 28, 2013 [↩]