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Can Keurig Green Mountain Gain More Altitude From Its Deal With Coke?

By Robert Hanley – Mar 18, 2014 at 2:00PM

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Keurig Green Mountain shareholders were smiling in early February after a product partnership and associated investment by beverage giant Coca-Cola led to a spike in shares. Should new investors climb aboard?


Source: Keurig Green Mountain.

Despite a dominating market share for its Keurig single-serve coffee franchise, Keurig Green Mountain (GMCR.DL) has been perennially dogged by short-seller criticism. This has most notably stemmed from hedge fund manager David Einhorn, who has questioned the company's inventory accounting and growth potential. Consequently, Keurig Green Mountain's shares have been volatile, which has no doubt been exacerbated by a 2012 patent expiration for the Keurig system. That weakened moat led to a rising list of single-serve challengers, including Starbucks' Verismo system. 

However, Keurig Green Mountain engineered a game-changing move in early February, disclosing a product partnership with Coca-Cola (KO -0.39%). The deal included the sale of a 10% stake to the beverage giant. So, is Keurig Green Mountain a good bet at the current price?

What's the value?
Keurig Green Mountain has ridden the fast-growing single-serve coffee market to new heights, more than quadrupling its sales over the past four fiscal years. Despite losing protection on a key patent in September 2012, the company has maintained its leadership position through a heavy research and development program. This has resulted in newer, multifunctional models like the Vue and Rivo systems. 

Keurig Green Mountain has also increased its franchise moat by continually widening its licensed-partner base. This strategy has added product diversity and has likely made its machines more valuable in the eyes of customers.

In its latest fiscal year, Keurig Green Mountain posted solid top-line growth, up 12.9%, aided by double-digit volume increases for both its brewer and portion pack product lines. More important, lower average green coffee prices allowed the company to improve its operating margin significantly, leading to a more than 30% jump in operating income. The net result was a healthy pickup in cash flow, providing funds to further invest in new product areas. This expansion includes a forthcoming entry into the soup category in partnership with food giant Campbell Soup.

An unbeatable combination
Of course, there is a limited population set of everyday coffee drinkers, estimated at 63% domestically as of 2012. Keurig Green Mountain is wise to pursue the broader population through an expansion of its product line, highlighted by the expected introduction of a cold beverage machine in fiscal year 2015. The major investment from Coca-Cola is a smart move for Keurig Green Mountain, as it solidifies the company's shareholder base while providing a cash infusion to escalate product development activities.

Coca-Cola, for its part, may be an even bigger winner from the tie-up, given its recent troubles at finding top-line growth. It has especially struggled in its core North American and European markets, which exhibited flat to negative volume increases in the company's latest fiscal year. Part of Coca-Cola's problem has been the inroads made by at-home beverage-machine makers, notably SodaStream (SODA). These products are anecdotally viewed as being more environmentally friendly and healthier thanks to an avoidance of ingredients with questionable nutritional value, including high-fructose corn syrup.

Like Green Mountain, SodaStream has been on a torrid growth trajectory recently, more than quadrupling its sales over the past five fiscal years. Not surprisingly, the company employs a similar business model, selling its machines near cost in the hopes of driving mass sales of higher margin refill cartridges and flavor bottles. 

The company's recent financial update for the fourth quarter was somewhat underwhelming, due primarily to higher-than-expected promotional activity. But double-digit sales of its machines across its major geographies are laying the groundwork for a larger future share of the at-home beverage market and higher future sales of its ancillary products.

The bottom line
As can be inferred from its positive stock price appreciation since the deal announcement, Keurig Green Mountain benefits greatly from its association with Coca-Cola; it adds both greater product line diversity and enhanced distribution capabilities. Conversely, it benefits Coca-Cola by giving it a prominent placement in Keurig Green Mountain's forthcoming cold-beverage ecosystem. This will hopefully help Coca-Cola to avoid further sales erosion from the advances of the at-home beverage upstarts, like SodaStream. 

Keurig Green Mountain's stock price is certainly more expensive than it was prior to the deal, courtesy of a roughly 40% pop since then. Its enhanced growth profile, however, likely warrants the higher valuation. The stock should be a core position for investors in the food and beverage sector. 

Robert Hanley owns shares of Keurig Green Mountain. The Motley Fool recommends Coca-Cola, Keurig Green Mountain, SodaStream, and Starbucks. The Motley Fool owns shares of Coca-Cola, SodaStream, and Starbucks and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. 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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