Green Mountain Coffee GMCR S
November 12, 2009 - 8:33am EST by
2009 2010
Price: 69.00 EPS $1.15 $1.78
Shares Out. (in M): 43 P/E 60.0x 39.0x
Market Cap (in $M): 2,970 P/FCF nm nm
Net Debt (in $M): -220 EBIT 78 132
TEV ($): 2,750 TEV/EBIT 35.0x 21.0x
Borrow Cost: NA

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Green Mountain is best known for its Keurig brand of single-serve coffee machines.  The business model is the classic razor/razor blade approach, where they give away the brewers and profit off of the subsequent sale of the coffee pods.  The company has been growing like a weed, through a combination of selling brewers to new distribution outlets, selling lower-priced brewers, and promoting aggressively to help sell-through.  However, they are burning cash and not making any incremental money from these brewere sales, leading a reasonable (i.e., non-kool aid-drinking "sell-side") analyst to ask whether this business model actually works.


1) Giving away machines is fine, as long as you get to sell the pods to generate some profits.  However, the data shows otherwise.  In the last 3 quarters, the company has sold 1.6m brewers on top of a base of 2.6m, but the number of pods they sell per quarter only increased 7%.  In other words, the usage rate per incremental machine sold is .2/day, against an average rate of 1.3 (assuming 50% of machines older than 2 years are obsolete, which flatters this statistic).  I believe this is for 3 reasons:

            1) The machine is more likely to be given as a gift now instead of being bought for personal use, and the recipient may not want to use the machine that regularly.

            2) The highest selling machine is the low-priced Mini, which is inconvenient to use versus the multi-cup alternatives, and convenience is the main reason for using Keurig.

            3) The economy is taking its toll, and unemployed people are making a pot of coffee for $.20 a cup instead of using k-cups for $.50.

            4) One of the top selling items in the housewares segment is a reusable coffee filter for the Keurig machines.  Other websites with similar filters claim to have sold tens of thousands of units.  If people decide to use the coffee machine as a single use device, but to use their own coffee in it, the business model falls apart.  Management's response to this question was quite reassuring last night:


"all of the research that we're doing and all the modeling we're doing would say our trends remain consistent with what our expectations are going forward"




Last quarter they explained the drop in the tie rate as having to do with the initial K-cups that are included in the brewer box.  This should be under a one week supply, and have no discernable impact or lagged effect on K-cup sales.  In other words, this is BS. 


For next quarter, the guidance is for revenue to grow 65% or $130 million, yet for operating profit to grow $5 million, year over year.  It is fine to focus on the number of brewers sold and assume that they do not contribute to EBIT, but it is worrying that the fleet of brewers will have more than doubled in a year, and their profits are barely growing.


2) The channel-fill game is over.  Aside from a few supermarkets, there are no more doors to sell into after the Wal-Mart contract last quarter.  The market is saturated.  Our channel checks show that same-store sales are roughly flat, so most gains are from sell-in to new channels (I think there could be some channel stuffing this quarter, based on these surveys).  In fact, they trumpet how strong the supermarket channel has been for them, but they have gone from 2,600 supermarkets in 12/08 to 8,500 in 9/09, an increase of 225%, while their supermarket sales are up only 172% year-over-year (and less than that in the December to September time period, and doesn't include the fact that there is channel fill in there also).


3) Competition will get better, and the runway is limited.  The reason the European guys have struggled in the US (while dominating in Europe, where single-serve coffee is widely penetrated) is that they focused on taste, not convenience.  In addition, since Keurig's patents around the K-Cup expire in 2012, every coffee maker will be able to make the pod without paying GMCR a royalty.  Management discusses making larger pods and iced teas and other random stuff, but the fact remains that Starbucks can sell a K-cup of their coffee in 2012 and GMCR will not get paid a cent.  Speaking of Starbucks, their Via instant coffee tastes a lot better than Keurig and you don't need a machine.


4) Even if you believe none of these arguments, the stock is still overvalued.  Since they only make money on royalties, assume they dominate the market and see what sort of profit they generate.  I have assumed high usage rate for the office/hotel market and a reasonable one for the home market.


  home office hotel total
units      110.0          6.0          4.0  
penetration 25.0% 50.0% 25.0%  
keurig share 60.0% 50.0% 50.0%  
keuric units 16.5 1.5 0.5  
usage/day 1.0 6.0 2.0  
k-cups sold 6,023 3,285 365 9,673
revs/cup 0.06 0.06 0.06  
ebit margin 50.0% 50.0% 50.0%  
net margin 30.0% 30.0% 30.0%  
profit 108.4 59.1 6.6 174.1
multiple               15.0
shares               44.0
per share        $    59.35
time to reach full penetration (years)             5.0
discount rate       8%
discounted value        $    40.40
note:household penetration calculation  
% of US that drinks coffee every day   60%
% that drinks in-home     75%
% over the poverty line     75%
  total addressable population     34%
max penetration of addressable population 75%
ultimate penetration     25%




In summary, I think this story stock could easily unravel after a poor holiday season (the consumer is not in the mood to buy $100 coffee makers, from what I can tell) and a growing realization that the target customer base is smaller than analysts expect. 


poor holiday sales

insider selling that will likely start in a few days

sell-side analysts actually analyzing the company

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