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Some companies climb a wall of worry. Green Mountain Coffee Roasters (Nasdaq: GMCR ) may as well brew a hole right through it.
The company behind the popular Keurig single-cup coffee brewers -- and the K-Cup portion packs that fuel them -- is under attack again. After seeing the stock more than triple in 2009, I guess some bears are just gluttons for punishment.
Fusion Investing's Dean Morel is the latest to take a whack at the java giant. Like most grim takes on Green Mountain, Morel is concerned about patent expirations, the faddish nature of K-Cups, and the stock's valuation.
Let's tackle those three bugaboos.
Let's start with the patents. Green Mountain owns 33 domestic and 73 international Keurig-related patents. The bearish case centers on the two primary patents behind the K-Cup refills that expire in two years. Green Mountain collects $0.064 for every licensed K-Cup sold; if the technology goes generic, those revenue streams would dry up. It could also lead to a price war, which may be great for consumers and the sale of Keurig brewers, but would eat into the margins of Green Mountain's own K-Cups.
Not so fast.
"The two principal patents associated with our current generation K-Cup portion packs will expire in 2012, and we have pending patent applications associated with this technology which, if ultimately issued as patents, would have expiration dates extending to 2023," explains the company in its 10-K filed back in November. "Our agreements with our roasters are more than simple patent licenses. Roasters with agreements with the Company have access to and benefit from Keurig's technology and distribution network and we believe these benefits will help us to maintain royalty revenue irrespective of our patent status."
I'm no patent attorney, but even if the chances are remote for Green Mountain to extend its patents through 2023, I still don't like everyone assuming that the patents will definitely die come 2012.
The latter part of the filing's paragraph is also worth heeding. No matter what happens with the K-Cup patents, Green Mountain will still be the company putting out Keurig single-cup brewers. It establishes contact with the consumer and gives them their first taste, making Green Mountain the logical source for refill subscriptions.
Green Mountain has been preparing for the demise of its K-Cup patents recently by snapping up Diedrich Coffee (Nasdaq: DDRX ) and the Timothy's wholesale business, the more popular K-Cup brands.
Starbucks (Nasdaq: SBUX ) , Peet's Coffee & Tea (Nasdaq: PEET ) , and former patent infringer Kraft (NYSE: KFT ) can always wait until 2012 -- or possibly even 2023 -- to dive in, but Green Mountain will have even more time to strengthen its share of the market as it drums up alternatives to refill its moat. Being promoted through Keurig itself might not command that $0.064-a-pack tariff in the future, but it's going to be worth something.
The good, the fad, and the ugly
Morel brings up Crocs (Nasdaq: CROX ) as a cautionary tale on inventory bloating, even though Green Mountain's inventory levels are more than appropriate, given its healthy growth. I'm guessing he just wanted to find a way to box Green Mountain into the same article with the poster child for faddishness.
I've had a Keurig brewer at home for more than two years now. It certainly doesn't seem like a pet rock or a Zhu Zhu hamster to me. It's not as if growth is waning at Green Mountain. Revenue soared 65% in its latest quarter, with earnings more than doubling.
There may have been a sequential dip in K-Cup sales during the previous quarter, but that's due to the seasonality of the business. (There were sequential dips in the fiscal third quarters of the 2007 and 2008 fiscal years, too.)
Another bogus warning sign that K-Cups may be a passing craze is that K-Cup sales aren't growing as quickly as the established base of brewers. That's true, but one also has to consider that the first wave of Keurig machines went into corporate break rooms, restaurants, and lodging establishments. Keurig's push into consumer kitchens means fewer K-Cups per machine. One also has to consider the recession's impact on corporate layoffs, emptier restaurants, and diminished hotel and inn occupancy rates.
A hill of beans
The valuation argument is harder to defend. Green Mountain's stock wasn't cheap a year ago -- and it's trading three times higher today.
However, growth has a funny way of justifying market premiums. Analysts see Green Mountain's earnings climbing 68%, to $1.90 a share this year, and the stock is currently fetching 44 times that profit target. Wall Street sees net income rising 38% in fiscal 2011, yet the stock now trades at an earnings multiple of 31 times that bottom-line mark.
In other words, Green Mountain is still growing faster than its forward P/E ratios. At this point, I should note how Green Mountain has also beaten Wall Street expectations in each of the past eight quarters, making analyst guesstimates look decidedly conservative.
A lot can happen in the future. Starbucks may make a dent with its VIA instant coffee. A superior single-cup platform may arise. Jarden's (NYSE: JAH ) Mr. Coffee and Conair's Cuisinart are rolling out new K-Cup based coffee makers this year, but they may just as quickly hop on to the next hottest thing if it materializes.
However, the patent concerns, faddish knocks, and even valuation relative to its growth appear to be weaker bearish brews than the pundits think they're sipping.