Why I Think Green Mountain Has Huge Upside

Green Mountain Coffee Roasters (NASDAQ: GMCR  )  brand value is ever increasing, and the company's performance has been rock solid in fiscal 2013. Despite a number of skeptics, the company will be a strong performer going forward. Green Mountain's revenue growth has been robust, driven by strong sales of K-Cups, in spite of rising competition from private-label alternatives. 

Strong financials
In the last fiscal year, Green Mountain's top-line revenues stood at $4.36 billion, a 16% year-over-year increase. Robust sales of high-margin K-Cup portion packs have boosted the company's gross margins. In fiscal 2012, the company's gross margins stood at 32.9%, which ramped up to 37.2% in fiscal 2013, an increase of 430 basis points. And if the company can sustain the sales of its Keurig and other brewers and portion packs, its margin profile should continue to ramp up, driven by higher gross margins.

In fiscal 2013, Green Mountain's operating margin stood at 17.6% and its net income margin at 11.1%. The company's diluted earnings per share for the year stood at $3.16, which is a 39% increase from the previous year. The company's board authorized a share repurchase plan for buying back $1 billion of stock after the expiration of its current plan, under which $140 million is still remaining. In addition, the company is also returning cash to shareholders in the form of a small cash dividend.

Growing customer base
Even though some of Green Mountain's patents have expired, its brand value and high-quality coffee is aiding the company. Revenue growth in the last year was driven by a strong consumer adoption of single-serve coffee and the subsequent portion packs. Revenues from brewers and accessories grew 9% to $828 million, and portion pack sales shot up 18% to $3.2 billion. Portion packs saw robust growth due to a 26% increase in unit volume, which was offset in small part by a 1% decline in price realization and a 4% decrease in product mix.

Green Mountain will penetrate into more homes in the U.S. and abroad, and its recurring revenue generation model will help top- and bottom-line numbers. The company is well positioned as a category leader in the single-serve hot beverage marketplace, but the Keurig system is present in only 13% of U.S. households. And starting in fiscal 2014, Green Mountain is planning to launch the Keurig system in the U.K., Australia, South Korea, and Sweden.

The company's plan to grow its customer base outside the U.S. and Canada will be a major plus. Its U.S. business grew 18% year over year, and the Canadian segment grew 4% year over year. Green Mountain should be able to build on its reputation and great products and grow its customer base in the planned territories in 2014. 

Green Mountain's strategy has always been to sell single-cup brewers at cost and generate more continuous demand for the portion packs. Revenues from portion packs made up 73% of total revenues in fiscal 2013, whereas brewer sales made up only 19% of total sales. The company's overseas launch should be aided by its partnership with leading coffee brands like Starbucks  (NASDAQ: SBUX  ) .

As Starbucks has a much bigger global footprint relative to Green Mountain, the company's Starbucks-branded K-Cups will provide a substantial tailwind for international growth. Starbucks is a favorite among global coffee lovers, but it is largely perceived as a casual restaurant, not a maker of at-home brewers. So Green Mountain will be able to capitalize on the brand value of Starbucks to fuel its expansion overseas. 

Enhancing the moat
Green Mountain's CFO disclosed in the earnings call that the company sold 8.3 billion portion packs in the last year, which is a 22% year-over-year increase from the 6.8 billion packs the company sold in fiscal 2012. So this data point proves that the company's skeptics have been wrong about the company's portion pack unit sales.

The company's patent expirations led to unlicensed portion packs for the Keurig platform entering the market, at prices that are 15% to 25% below what the K-Cup packs cost. The market share of portion packs from private-label sellers was roughly 12% of the Keurig platform at the end of the last quarter. 

However, Green Mountain is making more promotional campaigns to grow its revenues amid the competition, and to avoid material price erosion for its products. And the company is in discussions with a number of private labels in the market to convert them into licensed partners of the company.

Also, the company is gearing up to launch a new line of Keurig brewers, which will have an interactive technology component on all Keurig brew packs, and it's possible this system will be configured to brew only Green Mountain licensed packs. As a result, Green Mountain will be able to squeeze out competitors. Creating brewers that brew only Green Mountain-licensed portion packs and converting private-label brands into partners are two major positives for the company, and will help grow its competitive advantage in the future. 

Going forward
Continued consumer demand for single-serve coffee will provide an additional tailwind to drive sales of the Keurig brewing system, which in turn will fuel the sales momentum of K-Cups. A newer and innovative line of brewers will aid the company's penetration rates in North America. The company's international growth plans will get into gear starting in 2014. Green Mountain's gross margins and earnings will grow substantially as a result of these strategic decisions. Also, the company is buying back a lot of stock to bolster its earnings per share, which will provide additional upside for Green Mountain stock.

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