How Low Can Green Mountain Coffee Roasters Go?

Shares of Green Mountain Coffee Roasters (Nasdaq: GMCR  ) hit a 52-week low Monday. Let's take a look at how they got there and whether cloudy skies are still in the forecast.

How it got here
Some would argue that Green Mountain, maker of the Keurig single-brew coffee system and K-Cups, has tumbled to new lows because it drew the ire of noted short-seller David Einhorn and T2 Capital Partners money manager Whitney Tilson. But it was actually much more than just that.

Green Mountain finds itself at a new low for three primary reasons. First, the company has done a poor job at anticipating the future demand for its K-Cups. Its recent quarter marked the sixth time in seven quarters that inventory levels grew faster than sales -- a recipe for challenged gross margins.

Second, competition in the coffee sector is intense. Starbucks (Nasdaq: SBUX  ) , with whom Green Mountain is partnered, is coming out with its own single-brew machine, known as the Verismo, which will be a direct-ish competitor to the Keurig brand. Although Dunkin' Brands (Nasdaq: DNKN  ) also has a partnership with Green Mountain, Dunkin' restaurants are more known as quick stops than places customers will converge for hours (like Starbucks), so it inadvertently takes away the "give-it-to-me-now" advantage that Green Mountain K-Cup's possess.

Finally, Green Mountain's dominance is on a short leash with the main patents on its K-Cups set to expire in September. With nothing to stop competitors from essentially copying the idea, even more of Green Mountain's sales could be at risk.

How it stacks up
Let's see how Green Mountain Coffee Roasters stacks up next to its peers.

GMCR Chart

GMCR data by YCharts

Green Mountain can't properly predict consumer demand, and that's a major problem. As Foolish colleague Shubh Datta wisely noted, this situation seems very reminiscent of Krispy Kreme Doughnuts (NYSE: KKD  ) one decade ago, when it over-expanded without truly understanding its costs or consumer demand.

Company

Price/ Book

Price/ Cash Flow

Forward P/E

5-Year Revenue CAGR

Green Mountain Coffee Roasters 1.8 15.8 8.2 63.8%
Starbucks 7.9 27.3 23.2 8.5%
Dunkin' Brands 5.2 28.0 22.2 N/A
McDonald's (NYSE: MCD  ) 6.3 13.1 14.6 4.6%

Source: Morningstar, author's calculations. N/A = Dunkin' Brands doesn't have five years of revenue history available. CAGR = compound annual growth rate.

No, that's not a misprint. Green Mountain really has grown by nearly 64% annually over the past five years. On paper it appears to be an amazing value and given the large amount of shares currently held short, it could be a prime short-squeeze candidate. However, if the company has no clue how to control its inventory levels, then gross margin will continue to fall, rendering its low valuation very fair.

On the flip side, Starbucks continues to prove to investors why it's the king of the coffee sector. The company's expansion plans into China coupled with its fresh menu options keep its customers coming back for more. Don't count out Dunkin' Brands, either, which has done very well for itself and has established itself well on the East Coast of the U.S., giving it potential to expand west, or internationally. McDonald's also serves an important role in garnering bargain-shopping coffee customers; from the three coffee producers mentioned above it provides the strongest dividend.

What's next
Now for the real question: What's next for Green Mountain? That question is really going to depend on whether it can get its inventory levels under control and if it can continue to develop new products that will excite consumers to the point of purchase.

Our very own CAPS community gives the company a two-star rating (out of five), with 69.1% of members with an opinion on the stock expecting it to outperform. I have not made a CAPScall on Green Mountain as I find it to be one of the most confusing stocks ever!

On one hand, Green Mountain looks like a very compelling value. Keurig sales rose 21% in the latest quarter with K-Cup sales up 59%. Although gross margin tumbled 210 basis points, the company is still very profitable, and at eight times forward earnings, an enticing value. On the other hand, Green Mountain is driving blind and just assuming demand will continue unabated despite warning signs of increased competition from Starbucks, Dunkin' Brands, and McDonald's. If Green Mountain could find a way to lower inventory levels and boost margins I'd probably be willing to make it an outperform pick in my CAPS portfolio, but I could just as easily see it heading lower if margins keep worsening.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Green Mountain Coffee Roasters, Starbucks, and McDonald's, as well as writing covered calls on Starbucks 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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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 22, 2012, at 1:25 PM, bobg2004 wrote:

    ..."Green Mountain's dominance is on a short leash with the main patents on its K-Cups set to expire in September. With nothing to stop competitors from essentially copying the idea, even more of Green Mountain's sales could be at risk."

    This is a false statement, As we all know, K-cup patent IS NOT EXPIRING in September.

    The added opinion about sales being at risk is pure spin fantasy as is most of the article.

    Isn't Motley suppose to be spin free?

    Demand retraction and banning of Sean Williams on MF.

  • Report this Comment On May 22, 2012, at 3:13 PM, DanCooper76 wrote:

    bobg2004, you may want to read this:

    http://www.bloomberg.com/news/2011-11-18/green-mountain-s-ex...

    Williams' opinion would seem to be valid on first read. As such he should be allowed to fool on.

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