Is Green Mountain Too Expensive?

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The glow of Green Mountain Coffee Roasters' (NAS: GMCR) bear-thumping quarterly report last week is dimming.

Green Mountain is coming under attack today -- on price.

No, we're not talking about the price of the shares, though bears certainly have plenty to say about that. We're talking about the value of a K-Cup.

The New York Times' Oliver Strand is taking the single-cup brewing market to task.

He offers up the Folgers Black Silk blend that's available in K-Cup portion packs priced at $10.69 for a dozen pods. Since each capsule contains eight grams of coffee, cracking open nearly 57 K-Cups to get a pound of coffee would run you close to $50.50.

Ouch! That's a lot of dough for Joe.

Strand's argument is flawed -- and I'll get to that -- but first I want to point out that he's getting gouged. If he's paying $0.89 for per K-Cup he's being robbed.

I just looked up Folgers Black Silk on Amazon.com. The leading online e-tailer sells it in 36-count packaging -- essentially three of the 12-packs -- for $16.97. In other words, we're really talking about $0.47 per K-Cup, or $26.69 a pound.

I know it's still high, but we're not done yet. If you're fan of a particular blend, Amazon will give you a 15% discount under its "Subscribe and Save" program for scheduling automatic deliveries.

The price of convenience
If single-cup brews are priced so outrageously high, we live in a world of suckers. Keurig shipped a whopping 4.2 million brewers through its partners during the holiday quarter and revenue more than doubled to $1.16 billion.

These poor saps just spent $100 or more on a brewer only to overpay for coffee? Idiots!

Well, as one of those idiots, I think I need to explain the price of convenience. Having a neat and fresh cup of premium coffee in the convenience of home or in an office break room is worth $0.50 to a lot of people. It's immediate. It doesn't end in a pot full of coffee that will lose its zing before being cleaned. With roughly 200 varieties -- and counting -- it also opens up the customization process.

K-Cups are also not only convenient but cheap when compared to trekking out to your barista haven of choice and forking over two bucks for a somewhat similar brew.

Greenberg mountain coffee stock roaster
CNBC star Herb Greenberg pounded on the New York Times article this morning.

"A price war is inevitable," he writes. "Not because of the ridiculously high price of convenience, but because that's what happens when a product comes off patent."

Bears have rallied around the K-Cup patent expirations that kick in later this year. This is a concern, but I think critics are blowing things out of proportion.

"It's no different than a drug going off patent," Greenberg writes, and he couldn't be more wrong.

When a drug loses its patent protection, generic-drug makers rush off to formulate an exact duplicate of the medication. This doesn't play out the same way with consumer goods. There is brand loyalty. There are differences in price and flavor.

This is never purely an economic decision. Head out to your local grocery store and you'll see Coke and Pepsi bottles selling for two to three times what the generic house brand is fetching. The price disparity is outrageous. Cola is cola. However, fans of a particular brand taste the difference and gladly pay a premium.

Green Mountain has been planning for this day all along. It has acquired many of the most popular K-Cup brands beyond its namesake brews. Timothy's, Coffee People, Gloria Jean's, and Diedrich have all been snapped up by the company. Deals for regional faves Tully's and Van Houtte open up even more possibilities.

The heavy hitters moved in toward the latter half of last year, as Dunkin' Brands (NAS: DNKN) began offering Dunkin' Donuts K-Cups this past summer and Starbucks (NAS: SBUX) introduced K-Cups in November.

Why did Dunkin' and Starbucks decide to play nice with Green Mountain when they could have just waited until later this year when the patents expired? For Starbucks it may have been the exclusivity of being the sole "super premium" K-Cup brand. For Dunkin' it could have been the fear of being left behind. When millions of people are buying Keurig machines every quarter and settling on their favorite brews you don't want to arrive unfashionably late.

Black coffee to the future
There are certainly other reasons to play nice with Green Mountain. Next month it will introduce the second generation of Keurig brewers, complete with what will likely be fresh patents on new portion packs.

This won't move the needle right away. Green Mountain is positioning this as a high-end system. Green Mountain is also working with a European partner to introduce an espresso-based system in North America.

Even post-patent expiration it's not as if Green Mountain will be powerless. It's not the Keurig patents that are running out. It will keep selling the machines. As K-Cup prices get cheaper, won't it sell even more brewers, which can begin to grow from loss leaders to profit centers? Renegades like Treehouse Foods (NYS: THS) -- the private label specialist that Green Mountain sued two years ago for trying to circumvent Keurig patents by packaging instant coffee in a K-Cup-like pod -- won't be invited to offer samples in new brewers or sell through Green Mountain's website.

Bears feel that K-Cup patents expiring are the end of the world, but do they realize that Keurig itself sells a reusable filter that consumers can fill with any coffee grounds to make do in a pinch? Keurig is cool with that, because it knows that the masses will still choose convenience and K-Cup brands over cheaper workarounds.

At the end of the day, analysts that are fully versed in Green Mountain's patent challenges see profitability climbing 63% this year and another 36% in fiscal 2013 after the patents expire. Is Green Mountain really that expensive now fetching 18 times next year's projected profitability with that kind of momentum?

A little skepticism is always warranted, but Green Mountain's coffee and its stock are cheaper than you probably think.

Shares of Green Mountain have popped sevenfold since I originally recommended the java heavy to Rule Breakers subscribers three years ago. It's clearly been a big winner for the growth stock newsletter service, but if you want to discover the newsletter service's next Rule-Breaking multibagger, a free report tells all. Check it out before it's gone.

At the time this article was published Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story, except for Green Mountain. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.The Motley Fool owns shares of Starbucks.Motley Fool newsletter serviceshave recommended buying shares of Starbucks and Green Mountain Coffee Roasters.Motley Fool newsletter serviceshave recommended creating a lurking gator position in Green Mountain Coffee Roasters. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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