K-Cups: Brilliant Move or Sinking Ship for Starbucks?

Now that Starbucks (Nasdaq: SBUX  ) is selling some flavors in K-Cup packs designed for Green Mountain Coffee Roasters' (Nasdaq: GMCR  ) Keurig brewers, I don't see a way around asking whether these pods make legitimate sense for the coffee maven.

Was Howard Schultz stupid to back away from creating a single-cup brewing system? I'm going to put that question to you again at the end of this piece. First, let's talk about what to expect now that Starbucks is distributing K-Cup blends to stores. Per the latest 10-Q:

Our global consumer products group ("CPG") represents another important profitable growth opportunity for us. CPG continued its recent momentum completing the first full quarter under our direct distribution model for packaged coffee and tea. This model now gives us total control over the sell-in and distribution to retailers of these products. Starbucks- and Tazo-branded K-Cup portion packs will be added to the lineup, which already includes Starbucks VIA Ready Brew, beginning this fall.

This isn't just bluster. Among segments, CPG has the highest operating margins by far:

Segment

Trailing 12 Months

Fiscal 2010

Fiscal 2009

Fiscal 2008

United States 19.4% 17.1% 7.5% 6.1%
International 13.3% 9.8% 4.8% 5.2%
Consumer Products Group 31.7% 36.9% 41.8% 39.6%

Source: S&P Capital IQ.

Consider, too, the Starbucks brand name. The coffee champ was already making great margins before selling K-Cups. What happens when a well-known blend gets a call-out on your grocer's shelves? Only time will tell, but I believe the results will be positive.

I've already seen a degree of this in action. The local Kroger (NYSE: KR  ) subsidiary where we shop just started selling the Sumatra and House Blends. Costco (Nasdaq: COST  ) advertises Starbucks K-Cup blends at its site, while some fans report finding flavors on Safeway (NYSE: SWY  ) shelves.

I've only tried Sumatra so far, but it was every bit as good as I had hoped. I'll buy more, I'm sure, along with other custom flavors we've come to enjoy. (Van Houtte's Kenya, in particular, is a great blend.)

Maybe I'm alone in thinking this way. But if I'm not -- if legions are willing to pay a little extra per serving to have Starbucks in a K-Cup -- CPG profits could once more take a turn for the higher as Green Mountain increases volume and builds a durable brand of its own.

Think I'm wrong? Please vote in the poll below and then leave a comment to explain your thinking -- or let us know if you have a better stock idea. You can also add Green Mountain Coffee Roasters or Starbucks to your Foolish Watchlist for ongoing coverage.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

The Motley Fool owns shares of Costco and Starbucks. Motley Fool newsletter services have recommended buying shares of Costco, Starbucks, and Green Mountain Coffee Roasters and creating a lurking gator position in Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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