Keurig Green Mountain, Inc. to Get Java Jolt From Kraft Coffee Deal

The production and distribution deal means coffee lovers can probably find their favorite brand in a K-cup

Aug 28, 2014 at 7:30PM

The deal putting Maxwell House coffee into Keurig Green Mountain (NASDAQ:GMCR) pods means the single serve coffee maker specialist now represents all the major best-selling brands in the country, while the expansiveness of the deal overshadows the announcement earlier this month by Treehouse Foods (NYSE:THS) that it had cracked the code for Keurig's new 2.0 system suggesting we should see sales percolate higher.

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New, proprietary technology in the Keurig 2.0 system ought to lock out white label pod makers. Photo: Keurig Green Mountain

Its K-cup runneth over
Keurig jointly announced with Kraft Foods (NASDAQ:KRFT) last week the two had reached a multiyear licensing, manufacturing, and distribution agreement that would see the coffee system maker eventually take over from Kraft the production of pods for its popular brands including Gevalia, Yuban, and of course, Maxwell House.

Yet it also gives Keurig the rights to McDonald's (NYSE:MCD) line of McCafe coffee, which Kraft and the burger joint teamed up last year to distribute. Coffee has long been McDonald's strong suit, but last year the fast food chain attributed the introduction of its McCafe line of beverages as the reason behind a 70% surge in coffee sales.

Although coffee chains like Starbucks and Dunkin' Brands Dunkin' Donuts have been selling packaged coffee and K-cups through their stores and at supermarkets for several years now, it was just the other day that Kraft agreed to use its nationwide distribution network to ship the McCafe line to grocery stores and other food outlets.

An enigma wrapped in a riddle
Now Keurig will be taking over Kraft's pod production and distribution, and it ought to be enough to offset whatever fears investors may have had that Treehouse Foods had figured out a way to trick Keurig's newest brew system into using private label pods.

Keurig suffered a crisis of confidence and sales when the patents on its original K-cups expired in 2012. Operating on a razors-and-blades business model, Keurig sold the machines at a loss while realizing the greatest revenues and profits on the sale of its pods. But when white-label manufacturers like Treehouse were able to start producing knockoff pods the financial situation at Keurig took a dramatic turn for the worse.

Revenues that had jumped 72% in 2009 and then doubled in 2010, rose only 12.5% last year, while net income, which rose 46% and 150%, respectively, was 33% higher last year. Notably, pod pack sales that jumped 59% in 2012 rose just 18% in 2013.

If generic pod makers can tap into the new design already, one which Keurig has kept close to the vest, that could pressure sales and profits once again. Following Treehouse's announcement earlier this month that it developed a workaround to the technology -- in February it sued Keurig over the technology -- Keurig's stock pulled back 4%, though the Kraft deal has allowed the stock to more than make up for those concerns.

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The Maxwell House brand gives Keurig a complete lineup of the most popular coffee brands.

Good to the last drop
Generic competition notwithstanding, and as important as the McDonald's nexus is to the agreement with Kraft, having Maxwell House in its portfolio of pods gives Keurig all the major coffee brands. In May it signed a similar distribution agreement with J.M. Smucker for its Folger's coffee, the number one selling coffee brand by volume with around 15% of the market. Maxwell House is second at 10%, and because of the brand's popularity, could do more than just result in an incremental increase in revenues for Keurig.

After a planned transition period, Keurig will exclusively take over from Kraft the manufacturer of its branded Keurig packs, though the coffee that will be used will continue to be sourced, roasted, and blended by Kraft, which started making its own K-cup compatible pods after Keurig's patents expired. 

Coffee, the great equalizer
But it calls into question what the deal means for Kraft's Tassimo brewing system, which it manufactures in partnership with Bosch, though it could become the primary device Mondelez International sells to international markets.

Mondelez, which was spun off from Kraft in 2012. announced earlier this year it would be combining its coffee business with that of D.E. Master Blenders to create a new global pure-play coffee giant housing brands that include Gevalia, Tassimo, Senseo, and the international business of Maxwell House. The joint venture, which will be called Jacobs Douwe Egberts, will be the second-largest packaged coffee company in the world. Kraft may be deciding the Tassimo system would be better off marketed internationally. 

The Foolish bottom line
With a new four-cup unit coming to market, its half-gallon Bolt system introduced late last year, and the full range of major coffee producers lining up for the chance to have their coffees in the new Keurig machine, this coffee maker looks like it will have little trouble brewing up some hot sales growth.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, Keurig Green Mountain, McDonald's, and Starbucks. The Motley Fool owns shares of Starbucks and 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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