Is it Time to Join the Bulls in Keurig Green Mountain?

Keurig Green Mountain (NASDAQ: GMCR  ) has been a favorite target of short sellers. Most notably, hedge fund manager David Einhorn of Greenlight Capital questioned the company's growth potential in light of the 2012 expiration of key patents on its Keurig product line, as well as greater competition in the single-serve coffee space from major players, like Starbucks (NASDAQ: SBUX  ) . The company's sizable short interest, which stood at 9% of outstanding shares as of May 2014, has led to some significant historical volatility for its stock price that included a harrowing drop from mid-2011 to mid-2012.

However, Keurig Green Mountain's recent results seem to be finding greater favor with Mr. Market; this is highlighted by better-than-expected profitability in its latest financial update, which led to a subsequent double-digit pop in its share price. In addition, the company has shored up its shareholder base recently, as it agreed to sell a major stake in itself to beverage giant Coca-Cola as part of a product co-development partnership. So is Keurig Green Mountain a good bet at current prices?

What's the value?
Keurig Green Mountain is the king of the domestic, single-serve coffee segment; this is an enviable position given the recent growth of the segment, as estimates put it at more than 40% of ground coffee sales.  While the expiration of a key patent on its Keurig product line in 2012 could have ended Keurig Green Mountain's story, the company has been successful at expanding and broadening its base of licensor partners; this is highlighted by the additions of Swiss Miss and Lipton in the hot chocolate and tea categories, respectively. The net result for Keurig Green Mountain has been strong top-line growth of more than 450% over the past four fiscal years.

In fiscal 2014, Keurig Green Mountain has continued to build upon its long-term growth trajectory, evidenced by a 6.2% top-line gain that was a function of higher sales volume across its product portfolio. While average prices continued to drop for its brewers and portion packs, the company took advantage of its prior decision to lock in coffee prices, a wise move that helped to propel a sharp increase in operating profitability during the period. More importantly, Keurig Green Mountain's cash flow generation remained strong; this provided funds for its various growth initiatives, which include a next generation brewer that can handle both single-serve and carafe portions.

Looking into the crystal ball
Of course, with Keurig Green Mountain's top-line growth slipping into the single digits, much of the excitement surrounding the company centers on its proposed Keurig Cold machine; this product will move the company into the at-home carbonated beverage segment and was the obvious impetus for Coca-Cola's strategic investment. While having Coca-Cola in its corner will be a definite plus, success is by no means guaranteed given the competitors that want to own the segment, which estimates place at a $260 billion market globally.

At the top of the list is current segment kingpin Sodastream (NASDAQ: SODA  ) , which sold roughly 4.4 million carbonated beverage machines in its latest fiscal year. Like Keurig Green Mountain, Sodastream has benefited by selling its machines near cost; this has allowed it to create a diversified operating footprint as its current product distribution spans an estimated 45 countries. More importantly, the anecdotally low cost of its machines, at least for active users, has fueled growing sales of higher margin flavor packs; this fosters a profitable business model that is allowing the company to continue expanding around the world.

More worrisome for Keurig Green Mountain, though, may be Starbucks, the coffee house giant that is both a partner and competitor in the single-serve coffee business. Even though it has continued to ride expansion in both the retail and wholesale segments, evidenced by a double-digit top-line gain in fiscal 2014, Starbucks also has its eye on the carbonated beverage area, and it plans to roll out its Fizzio soda brand to stores in the current fiscal year. Rumors also claim that Starbucks is pondering a strategic investment in Sodastream, a blockbuster combination that would make life difficult for Keurig Green Mountain in the carbonated beverage space.

The bottom line
Keurig Green Mountain's recent results, and sale of a major stake to Coca-Cola, have silenced its detractors -- at least for the time being. While future profit growth is by no means a given, the company certainly seems to have stacked the deck in its favor with its latest moves and is likely to be a long-term winner for investors in the beverage sector.

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