Shares of Keurig Green Mountain (NASDAQ:GMCR) have been on a roll this year. The stock is up 40% so far in 2014 on the back of consistent results and news that Coca-Cola (NYSE:KO) has bought a 10% stake in the company. So, is Green Mountain still a buy after its solid gains?
Coca-Cola opens up a huge opportunity
The Coca-Cola deal is very strategic as Green Mountain is trying to expand its product mix to include cold beverages. Management is quite optimistic about the outcome of the Coca-Cola deal, stating that "with disruptive innovation, Keurig can do for cold beverages what we have done for hot coffee and tea at home."
The company has already enjoyed good earnings growth so far and if it is able to tap into cold beverages, its growth will increase. For the next five years, analysts expect Green Mountain's earnings to grow at an annual rate of 17%, but investors can expect upward revisions in this metric due to the company's foray into cold beverages.
The reason why I say this is because Green Mountain has signed a 10-year commercial and strategic agreement with Coca-Cola. The beverage giant has paid $1.25 billion for its 10% stake in Green Mountain. Going forward, Coke plans to use its strong marketing machinery to promote Green Mountain products in the U.S. and across 200 countries around the world.
Coke dominates the U.S. carbonated soft drink market with a share of around 40% and it has a strong presence in the international markets as well. Coke is looking to further strengthen its presence across its end-markets going forward, and it has doubled its advertising budget to $2 billion. So, Green Mountain should also benefit from Coke's marketing blitz as the beverage giant explores new growth areas, with k-cups being one of them.
Product innovations to drive growth
Apart from this, Green Mountain has lined up various new launches this year. The first is the introduction of the Keurig 2.0 hot system. The company believes that this new brewer is a breakthrough and will greatly broaden the appeal of its Keurig system. With Keurig 2.0, Green Mountain has launched a new function known as carafe, making it the first brewer to brew both single cups and a full carafe. And the biggest advantage is that it does this at the same price point.
Secondly, Green Mountain has introduced new interactive readable portion packs. It involves new lid graphics and Green Mountain's interactive technology. The coffeemaker expects that it will complete the roll out of this new pack by the end of 2014. The reason why this new portion pack is a big deal is because this new interactive technology will enable each Keurig 2.0 brewer to read bar codes on the Keurig Green Mountain portion packs. After that, the optimal brewing method for each beverage can be determined easily.
The third and the final transition on which Green Mountain plans to focus this year is the conversion of unlicensed players into licensed Keurig system partners. Unlicensed packs accounted for 14% of all k-cups in use on the Keurig system at the end of the last quarter, and this share is expected to rise in the near-term. However, the growth of unlicensed packs has slowed down and Green Mountain is looking to bring it down further by converting them into licensed players.
Green Mountain has already converted some of these players and is in talks with many other unlicensed participants, which it plans to convert in the next 12-18 months as Keurig 2.0 is introduced.
Green Mountain shares have surged remarkably ever since the Coca-Cola deal happened. As a result, the company now trades at 31 times earnings, which is expensive when compared to the industry average P/E of 19. But, Green Mountain deserves this premium since it has got a great opportunity to expand its business with the Coca-Cola deal, while the introduction of a new system can attract more customers.
Also, the conversion of unlicensed players to licensed ones will result in an increase in market share for Green Mountain. Hence, investors shouldn't be discouraged from buying the stock due to its premium valuation as earnings growth is expected in the future. Analysts project 17% annual growth in earnings per share for Green Mountain over the next five years, making it a good long-term bet.
Hence, we see that Green Mountain still looks like a good investment option despite significant share price gains. Investors should definitely consider this stock for their portfolios
Renu Singh has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and Keurig Green Mountain. The Motley Fool owns shares of Coca-Cola 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.