My view of Green Mountain Coffee Roasters (GMCR +0.00%) has evolved over time. It's actually one of the bigger swings that I've had as an investor. Earlier in the year, I thought that the company had no chance of recovery, and that the expiration of its patents was going to seal its fate. But my view has changed over time, and while I still wouldn't recommend the brand wholeheartedly, its strengths have become clearer to me. Here's what investors need to take away from the most recent earnings announcement, and why everyone should give Green Mountain a second look.
The value of competition
Before we talk about the details, I want to explain the basis on which I'm resting my renewed outlook for Green Mountain. It all started a few months ago with Five Guys founder Jerry Murrell. First of all, if you ever have a chance to see Murrell speak, jump on it -- he's a fantastic character. One of the most interesting things that he mentioned in his talk was his love of competition. Some of us in the audience were concerned that the high-margin burger model would fall apart once competitors entered the market. Murrell said that, conversely, that wasn't the case.
Instead, when new businesses entered into markets where a Five Guys already existed, both companies saw an increase in sales. By increasing the visibility of high-end burgers, it made consumers more open to the cost. If everyone has a $6 burger, then that's just the going rate. If it's a $6 burger at Five Guys and a $2 burger everywhere else, then Five Guys seems expensive. Obviously there's a limit to good competition -- 20 burger chains in a 2,500-person town isn't going to help anyone.
But the idea that competition can help a business really stuck with me, and it's helped me understand the Green Mountain story in a new way. In fact, I think the history of Starbucks (SBUX +0.59%) makes for an interesting comparison. When the company first hit the national stage, all you heard was how expensive a cup of coffee was. Now, almost no one thinks that the coffee is overly expensive because we've become acclimatized to the range due to the ubiquity of Starbucks and its competitors. With all that said, let's go back to Green Mountain.
The fourth quarter
Green Mountain beat expectations like a bass drum. Analysts had predicted earnings per share to come in at $0.48, and the company delivered $0.64 before one-time expenses. Adding to the rally -- and it is a proper rally, with the stock up 24% at midday -- Green Mountain increased its 2013 earnings-per-share forecast by about 3.5%. That's based on a new sales increase forecast of 15% to 20% for the same period.
The past quarter's strong finish was due to an unforeseen increase in K-Cup sales, which was the cause of my earlier-in-the-year concern. In an effort to battle the loss of its patents, Green Mountain recently released a new machine, which uses newly patented cup designs. While sales of the Vue cups are still low compared to the company's K-Cup line, Green Mountain anticipates the Vue taking over in the next few years.
In summary, the stock popped because it did better than the market expected -- an explanation that covers just about every major stock increase.
What investors should be looking for
There are three things investors should be watching in the future, keeping in mind that Green Mountain still has a long road ahead of it. Shares are down about 65% from last year's high, and are down 20% year to date. Green Mountain is still a beaten-down company, although now it seems to be a beaten-down company with new leadership and a new vision.
First, Green Mountain needs to keep up the sales growth of K-Cups. While the product isn't as new as the Vue, it makes up most of the company's income. I think this is the area where the introduction of the Starbucks Verisimo system is most helpful. By increasing awareness of the single-cup brew machines, it will get more people interested in purchasing the lower-priced Green Mountain machines.
Second, even though a switchover is a long way off, keep a close eye on Vue sales. The Vue represents the long-term success of the company, and any fall-off in sales could be bad news down the line. If overall sales are predicted to increase 15% to 20% next year, I'd want to see Vue sales up 30% or more.
Finally, keep an eye on other opportunities in this space. J.M. Smucker (SJM 0.95%) predicated a large amount of its next-year growth on a 50% increase in its branded K-Cup sales. If Green Mountain continues to outpace expectations, Smucker may do the same. Starbucks is the more obvious tag-along winner, and it looks like it might be in a good place to succeed off the back of Green Mountain's work.
