Should Green Mountain Be Worried About Whole Foods' Challenge?

Competition seems to be heating up in the single-serving coffee market. While Green Mountain Coffee Roasters (NASDAQ: GMCR  ) used to have a near-monopoly on consumables for the popular Keurig machines, several other companies have now started to manufacture K-Cups, the latest being Whole Foods Market (NASDAQ: WFM  ) . Aside from probably eating up some of Green Mountain's market share, the move may also bring prices down for K-Cups in general. Whole Foods is the biggest natural foods market in the US. Should Green Mountain be worried?

Sales slowdown
Despite its stock rising more than 60% year-to-date and more than 200% in the last twelve months, Green Mountain has been running into some sales trouble lately as its sales growth has slowed down somewhat. Earnings per share of $0.82 beat the Street's expectations by a healthy 6.6% but revenue of $967.1 million missed the $981 million consensus. Moreover, quarterly sales growth slowed to 11% from 14% in the last quarter .

Despite Green Mountain's patent expiring about a year ago, sales of K-Cups did rather well with an 18% increase to $751.7 million. However, sales of brewers and accessories fell 4%. Lower coffee costs benefited the company so gross margin increased to 42.1% for the quarter .

The company has a strong history of corporate partnerships, which has allayed some fears regarding increased competition in the K-Cup market. Recently, it announced a deal with Campbell Soup Company (NYSE: CPB  ) for the possibility to brew instant soup in your Keurig machine.

These soup packs will be sold only in places where Keurig-Brewed K-Cup varieties are sold. According to analysts, the move should provide a good boost to Campbell's product portfolio, as well as add some functionality to the Keurig machine . The deal will be welcomed for its addition to Campbell's distribution channel, as the canned soup market has been in decline for the last decade or so. As for Green Mountain, it gives consumers another reason to own a Keurig .

Increased competition
K-Cups account for the majority of Green Mountain's sales so increased competition in the field should be met with some concern. So far, no company has really been able to erode Green Mountain's dominant market share, but Whole Foods stepping up might be something of a game-changer. In any case, the news about Whole Foods' competing product offering sent Green Mountain stock down around 2.5 %.

In the third quarter, K-Cups accounted for some 78% of Green Mountain's total sales. Because Green Mountain gets such a large amount of its revenue from K-Cup sales, Whole Foods' move can be seen as a significant threat to the company's top-line. A bit more expensive, 12 of the 365 Everyday Value Brand K-cups will cost $8.99, compared to a 24-pack for $16.49 on Green Mountain's website . Whole Foods has apparently been working on shedding its image of a premium supermarket, expanding its budget offerings to draw in a wider range of clientele.

The bottom line
The expiration of its patent on K-Cups might be quite a serious threat to Green Mountain Coffee Roasters. Analysts have not been particularly pleased with the company's latest sales numbers, and the news of increased competition on the product from which it garners the majority of its sales sent some investors fleeing. While partnerships with companies like Campbell's may provide a lift to brewer sales, some analysts warn that the increased competition in the K-Cup market may be a more serious development than previously anticipated.

No Pitch


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Comments from our Foolish Readers

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  • Report this Comment On October 17, 2013, at 9:02 AM, andy8546 wrote:

    If Sales are slowing down, why did the company increase their guidance on August 2013 for the full year? Even in your own article you mention that sales of K-cups when increase 18% over a year ago.. A year ago was when most major grocery stores started offering their own brand of K-cups, yet Green Mountain K-Cups increased their sales.. So really there are no metrics that suggest sales of K-cups are slowing down, except creative headlines, specially in the face of GMCR increasing guidance for just 8 weeks ago. There is a lot of short interest out there and a lot of creative stories being floated around to drive the price down, but as time and time again has proved, that earnings will be up again this quarter, when the company announces in a 3 weeks.

  • Report this Comment On October 17, 2013, at 3:28 PM, canndad wrote:

    Whole Foods has 394 stores. With K-Cup distribution at more than 20,000 retail stores/15,000 supermarkets, how can it possibly be a major threat as you surmise. Please. Generics are the threat of which Whole foods is but ONE of more than 100 and counting.

    Your article doesn't even have a valid basis.

  • Report this Comment On October 17, 2013, at 5:01 PM, APerfectKCup wrote:

    I think Green Mountain is pretty safe here. Even thought their patent may have expired they have a solid dominance on the brewer machines. With increased exposure through other companies k cups they should keep pushing their machines. Hit me up at http://aperfectkcup.com if you want to talk more.

  • Report this Comment On October 17, 2013, at 8:25 PM, Karmaholic wrote:

    No mention of the price of coffee significantly dropping, which will increase profit margins?

    Plus, no mention of GMCR entering the carbonated soda business? I believe this is a 4Q entry we should be hearing about very soon, which will be giving Sodastream some serious competition.

    While K-cups are the major driver there is good guidance plus new organic growth on the way with new products.

    Einhorn is doing his job (shorting) well, but it is not a slam dunk by any means. (He may have increased his short position, but is he going to keep his full short position open into earnings?.)

    As mentioned by others, the speculative media stories appear to be just that. Speculation.

    Unless they issue updated lower guidance I cannot support a bearish position at this time.

    GLTA

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