Green Mountain Coffee Roasters (GMCR): Skeptical of the Keurig, But Accelerating Revenue Will Likely Push Shares Higher
February 17, 2009
Faddish Product
Part of the thesis behind Green Mountain Coffee Roasters related to its Keurig single cup brewing system and K-Cup single-cup filters. The thought is that the Keurig is now the “i-Pod of coffee brewers and single-cup is the MP3 player displacing portable CD players,” according to analysts covering the stock at Canaccord Adams. This is a pretty heavy claim. In my view, while the Keurig and single-cup coffee is an interesting product, the product does seem somewhat faddish, like the ionic breeze that came out of now defunct Sharper Image, or the TurboChef speed cook oven from TurboChef technologies, which was recently acquired by Middleby Corporation (MIDD). At the very least, there is a lot of product obsolescence risk to any future earnings stream. Here is the story of the Keurig according to Amazon.com:
Keurig is the pioneer of single cup brewing and introduced its single cup brewing systems to offices across North America in 1998. In Fall 2004, Keurig introduced their first brewers for home use in retail stores nationwide. With Keurig single cup brewers you can enjoy a fresh cup of gourmet coffee, tea, or hot cocoa brewed in less than a minute, without any measuring or grinding. Keurig’s gourmet coffee and tea partners offer more than 200 varieties of coffee, tea, and hot cocoa available in Keurig’s patented K-Cups. Keurig’s coffee and tea partners include Green Mountain Coffee, Diedrich, Gloria Jean’s, Timothy’s, Van Houtte, Celestial Seasonings, Bigelow, Twinings, Tully’s, Coffee People, Newman’s Own Organics, Caribou Coffee, and Emeril’s. The Keurig’s K-Cup portion packs contain a single portion of coffee, tea, or hot cocoa, and are a highly engineered, technologically sophisticated mini-brewer. The K-Cup seals in freshness by locking out oxygen, humidity, and light that can make coffee stale. The Keurig system enables customers to enjoy coffee house quality coffee in the comfort of their own home for a fraction of coffee house prices.
(Source: Amazon.com)
Unsustainable Competitive Advantage
While GMCR currently dominates the single-cup market, with about 50% of market share, the economic moat that GMCR has seems like it would be easy to traverse. The company has patents behind its Keurig product, but a coffee making device patent seems to me like a pretty easy patent to get around. Nonetheless, I will concede that Green Mountain was recently successful in its patent litigation against Kraft (KFT). Realistically, however, there is nothing in place that would stop a well capitalized competitor from developing a Kuerig like device that is even better. Even though the Keurig has brand recognition now and is probably a great product, coffee making devices as a brand do not constitute competitive advantage as brands in this category don’t necessarily lock in consumers and lower search costs. What is more, although Green Mountain is considered a trade down play by analysts during the recession, Keurig machines are sold at the higher end of household coffee makers.
There’s Plenty of Room to Run, but Watch Those Distribution Channels
Green Mountain probably has plenty of more room for pipeline fill, and monitoring their pipeline fill will be key to figuring out when sales growth has been exhausted. At this point, there seems like there is more room to run here. Most major appliance retailers already carry the Keurig. The remaining pipeline that needs to be filled mainly consists of the notoriously tough negotiator Wal-mart (WMT), Sears Holdings’ K-Mart (SHLD), Supermarkets and large club stores like Costco (COST), BJ’s Wholesale (BJ), and Sam’s Club (part of Wal-mart). Pipeline fill shouldn’t be too much trouble as the company sells the Keurig at cost, or near cost, giving the “razor” away, while relying on the K-cups (”the blade” in this case) for margin. I wouldn’t be surprised if Green Mountain became a favorite momentum stock if the company starts to handily beat analyst estimates and perceived fundamentals remain strong.
Poor Earnings Quality Calls For Caution to Growth Story
One thing that is notable about GMCR from a quantitative perspective is their lower quality of earnings, which I define as earnings that have a relatively high accrual component by use of a simple accrual ratio, and have used both the balance sheet approach and cash flow approach as a check in the case of materially different treatments for the respective statements. FY 2007 wasn’t too bad, but FY 2006 and FY 2008 had fairly high accrual components to earnings. The change from FY 2007 to FY 2008 makes me cautious, as it represents a significant deterioration in earnings quality. Also, note the large increase in net operating assets over the past 3 years, which is another negative, although one could argue on the other side that the firm is rapidly growing.
Accruals Ratio |
Annual Data |
|||
Balance Sheet Approach |
2008 |
2007 |
2006 |
2005 |
Operating Assets: |
||||
Total Assets |
357.65 |
264.53 |
234.01 |
91.15 |
-Cash & Equivalents |
0.80 |
2.82 |
1.07 |
6.25 |
356.85 |
261.71 |
232.94 |
84.90 |
|
Operating Liabilities: |
||||
Total Liabilities |
218.13 |
165.43 |
159.07 |
30.75 |
- Total Debt (ST & LT) |
123.55 |
90.11 |
102.97 |
8.75 |
94.58 |
75.32 |
56.10 |
22.00 |
|
Net Operating Assets |
262.27 |
186.39 |
176.84 |
62.90 |
% Change (yoy) |
41% |
5% |
181% |
|
Accruals |
75.88 |
9.55 |
113.94 |
|
Scale Adjustment |
224.33 |
181.62 |
119.87 |
|
Accruals Ratio |
33.83% |
5.26% |
95.05% |
|
CF statement approach |
||||
Accruals: |
||||
NI |
22.3 |
12.84 |
8.44 |
|
-CFO |
1.95 |
29.83 |
12.82 |
|
-CFI |
-48.31 |
-21.66 |
-114.17 |
|
Accruals |
68.66 |
4.67 |
109.79 |
|
Scale Adjustment |
224.33 |
181.62 |
119.87 |
|
Accrual Ratio |
30.61% |
2.57% |
91.59% |
|