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Green Mountain Coffee Roasters (NASDAQ: GMCR ) certainly has had its hands full lately, with a host of critics like hedge fund manager David Einhorn, as well as an ongoing SEC investigation into its accounting practices. The company has also seen strong challengers go after its Keurig single-serve empire, including forays by Starbucks (NASDAQ: SBUX ) and Kraft Foods through their Verismo and Tassimo systems, respectively. Despite the challenges, though, Green Mountain's focus on the single-serve segment was a wise choice given the segment's hot growth, estimated at 82% in 2012 versus 10% for the overall coffee market. So, does Green Mountain provide a good risk/reward payoff for investors?
What's the value?
Green Mountain's shares have been on a wild ride the past few years, nearly doubling in 2013 after a harrowing decline during 2012. The company's transition from hypergrowth in 2010 and 2011 to more moderate growth recently has been a little rocky, no doubt exacerbated by the September 2012 expiration of key patents on its Keurig system. However, the worst-case scenario of a market share collapse for Green Mountain's franchise hasn't materialized as the company has worked hard to keep high-profile partners in its fold, including Dunkin' Brands and Unilever's Lipton brand in the coffee and tea categories, respectively.
In fiscal year 2013, Green Mountain posted solid top-line growth of 12.9% aided by strong sales volume performances for both its brewing machine and portion pack segments. The company also reported a strong gain in operating profit, thanks in part to the positive effects of much lower green coffee costs on its gross margin. The net result for Green Mountain was a big pickup in operating cash flow, which reached $836 million for the period. This allowed Green Mountain to reinvest in new product development for its Keurig system, which includes its forthcoming introduction of fresh-brewed soups in partnership with Campbell Soup.
Naturally, competitors aren't exactly standing still. Starbucks introduced its Verismo system, which can make both coffee and espresso-based beverages. The company has used its vast domestic store network, roughly 11,400 at last count, to hawk its machines and hopefully leapfrog Green Mountain in the quest for single-serve segment superiority.
While Starbucks continues to focus on building its retail network, especially in the key Asia-Pacific region, the at-home segment has become an increasingly key area of concentration for the company, accounting for $1.4 billion in sales in fiscal year 2013. Starbucks' decision to wrest control of its at-home business from partner Kraft Foods in 2011 despite a painful $2.8 billion hit to its balance sheet exemplifies management's view of the importance of this product area. Fortunately for Green Mountain, Starbucks' management is smart enough to realize the value of a symbiotic relationship with the owner of the Keurig system. Green Mountain and Starbucks agreed in May 2013 to expand the breadth of their relationship, incorporating new products and geographies.
Of course, all is not rosy for Green Mountain, as a number of food retailers and quick-serve restaurant chains have taken advantage of the Keurig system's patent expiration to pursue alternative partnerships. Most notably, Canadian quick-serve giant Tim Hortons recently elected to standardize its single-serve offerings on Kraft Foods' Tassimo system. The loss was a blow to Green Mountain's Canadian growth story, given Tim Hortons' huge operating footprint of roughly 3,500 stores and its 42% quick serve market share.
The bottom line
Despite taking seemingly constant body shots from critics, Green Mountain continues to grow the value of its Keurig franchise with new product development plans that the company hopes will increase its market share among at-home coffee drinkers, currently estimated to be 13% of U.S. households.
Starbucks' recent moves to enhance its relationship with Green Mountain show how difficult it is to displace the market leader, especially when Green Mountain spends heavily on research and development in order to maintain its position. While the lack of a retail presence is a risk for Green Mountain's franchise, the opening of its first Keurig store in November provides a potential offset to the downside risk, as well as a promising channel for branding and future sales growth. Green Mountain may never outrun its critics, but this essentially debt-free innovator is a good bet in the coffee trade.
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