Just two short years ago, the market was convinced that Keurig Green Mountain's (GMCR.DL) expiring K-Cup patents would expose the company to hordes of competitors looking to profit from the fast-growing single-serve market. However, the company continues to prove the skeptics wrong as it just delivered another solid quarter. With the company's stock up nearly 18% after the stellar second-quarter earnings report the only question is can Keurig continue to defy the naysayers?
Keurig sales booming
Keurig's second-quarter sales topped $1.1 billion, 10% higher than the same quarter last year. Operating profit and earnings per share rose even faster, growing 23% and 18% versus the year-ago quarter, respectively. Sales were lifted by strong brewer sales volume as Keurig sold 32% more brewers versus the year-ago quarter due to discounting. Increased pod sales were the biggest top-line driver, increasing net sales volume by 15% after the company partnered with a slew of previously unlicensed brands.
Moreover, Keurig is benefiting from lower green coffee costs, having locked in low prices before the recent spike. Management says the favorable contracts extend through the back-half of 2014. However, if coffee prices remain elevated through the summer, Keurig's future results could be adversely affected.
Besides coffee costs, the other key number from the quarter was unlicensed pack share. Management says that unlicensed portion pack market share increased slightly from the end of the first quarter, when unlicensed share hit 14%. Growth in unlicensed pack market share is a key part of the bear thesis against Keurig. As Keurig partners with more brands, unlicensed share will continue to fall. Although terms of the deals are unknown, it is clear that the bear thesis has not panned out exactly as planned.
How will the future unfold?
Keurig continues to amaze despite the expiration of its K-Cup patents, but bears are still skeptical that the company can continue earning outsized returns. The company is undergoing three critical transitions that could make-or-break its future success: (1) the transition to Keurig Hot 2.0, (2) the transition to Keurig 2.0-compatible K-Cups, and (3) transition to Keurig Cold. Failure on any one of these fronts would have a material adverse effect on the company's value.
The next-generation Keurig Hot brewer is due out this fall. In addition to single-serve pods, the new system brews pods that produce a full carafe of coffee. According to a company survey, the no. 1 non-price reason that consumers had not yet bought a Keurig is that it does not offer a larger serving size. The addition of the carafe option may entice consumers who balked at Keurig 1.0 to buy Keurig 2.0.
In addition to generating excitement about the Keurig 2.0 system, the company must also stock store shelves with Keurig 2.0-compatible pods. Aside from execution-related hiccups, Keurig's biggest challenge will be getting newly licensed brands to market in time for the Keurig 2.0 launch. In fact, CEO Brian Kelley admitted on the conference call that some brands will not be manufactured in time for the launch. Given the company's other challenges, getting K-Cups on shelves should be a doable task.
Finally, Kelley added some color on Keurig Cold that gives investors reason for optimism. Few details are known about the at-home carbonation system, but Kelley says that the technology works and is currently being tweaked. This is terrific news for investors, considering that the feasibility of the technology was a key concern. However, even if Keurig Cold is a success, investors should be cautioned to avoid paying too much for the company's stock.
Foolish takeaway
The market is right to be excited about Keurig's second-quarter results. The company churned out a stellar quarter despite persistent warning alarms sounded by skeptics. However, investors should pay close attention to Keurig's ability to execute its Keurig 2.0 and Keurig Cold rollouts, both of which are due out over the coming year. If they company fails to execute, its stock may be fed to the bears.
