Why Keurig Green Mountain Shareholders Could Get Creamed

Shares of Keurig Green Mountain have been on an upward climb ever since Coca-Cola made an investment in the company. However, shareholders could soon regret hanging onto their shares.

Jun 12, 2014 at 5:30PM

Keurig Green Mountain's (NASDAQ:GMCR) stock price has been on a tear ever since it announced a partnership with Coca-Cola (NYSE:KO). The stock is up 50% since Feb. 5 -- the day before the announcement that made Coca-Cola the company's single largest shareholder and a leading partner on Keurig Cold. Keurig has been a top performer in many investors' portfolios, but the magic may soon run out. Shareholders who continue to hold Keurig shares could soon get creamed.

Pure momentum
It is never exactly clear why a stock's price rises or falls, but there is usually enough relevant news to make an informed guess as to why the market is moving. Keurig's astronomical rise over the last few months is linked to its partnership with Coca-Cola, which provides legitimacy and a strong advocate for its business.

However, there was not any news last Friday, when Keurig's stock price unexpectedly surged 8.4% heading into the weekend. While it is possible that a large investor is buying shares by the truckload or the market "just realized" that Keurig is worth 8.4% more than it thought the day before, there is a more plausible explanation. Christopher Rich, head options strategist at JonesTrading Institutional Services, told Bloomberg that "[Traders] are wary going into the weekend in case there is an announcement of some kind."

If Rich is correct, Keurig's stock price is surging based on speculation that an announcement could be made that sends shares higher in the coming days or weeks. Such speculation may be valid. I have argued before that Coca-Cola will acquire Keurig soon if it ever does, but I also warned that Keurig's uncertain future makes the move too risky for Coca-Cola to make at this point in time.

In any case, a stock price based largely on speculation of an acquisition -- rather than the value of the underlying business -- is doomed to collapse if the speculation proves false.

A pricey stock with a dicey future
Keurig's future rests in the hands of its next-generation brewers. Keurig 2.0 upgrades the current Keurig Hot brewer, and Keurig Cold will debut as the company's first at-home carbonation system. There is a lot of buzz surrounding both brewers, but their ultimate success will not be known until they hit store shelves.

Keurig 2.0 will have to overcome Keurig 1.0's enormous success. Nearly one in seven U.S. countertops has a Keurig 1.0 -- a testament to the brewer's stunning popularity. In order for Keurig 2.0 to succeed, it needs to entice a substantial portion of consumers who already own a single-serve brewer to upgrade to a new one. Keurig 2.0's carafe feature, which allows consumers to brew a full pot of coffee, could lure owners of drip coffee makers. However, investors will have to wait until after its fall 2014 release to see if Keurig 1.0 owners see value in the carafe feature.

While Keurig 2.0 is set to hit shelves this fall, no firm launch date has been announced for Keurig Cold. CEO Brian Kelley told investors on the company's second-quarter conference call that the at-home carbonation platform's technology works as designed, and its development is on schedule. Coca-Cola's partnership on the platform and investment in Keurig's equity gives investors reason to be confident about the platform's prospects.

However, the market's optimism seems to outstretch any reasonable valuation of the company. At a recent price near $120, Keurig's market capitalization is approaching $20 billion. That values it at 30 times forward earnings. The stock's PEG ratio (price-to-earnings growth) is 1.75. A good rule of thumb is to buy when the PEG ratio is 1 or below. At its current multiple, Keurig must grow earnings per share at a higher rate in the future than it has in the past just to justify its current price. This may happen, but it is not a good risk-reward for long-term investors.

Foolish takeaway
When traders start bidding up the price of a stock for speculative reasons, it is usually time for long-term investors to make their exit. Keurig is a pricey stock with an uncertain future, and traders are buying in hope of an announcement that sends the stock even higher in the coming weeks. This is a recipe for short-term profits and long-term regrets. Buying Keurig at 30 times earnings seems unreasonable given its uncertain future, which is why the stock could fall off a cliff in the coming months if the company fails to live up to expectations. Shareholders beware.

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Ted Cooper owns shares of Coca-Cola. The Motley Fool recommends Coca-Cola and Keurig Green Mountain. The Motley Fool has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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