Cheaper K-Cups: Good for Us, But Bad for Keurig's Maker

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K-cupsAs far as java sippers go, Green Mountain Coffee Roasters (GMCR) is hot.

This Vermont company has seen its Keurig devices become the brewer of choice among fans of premium coffee in one-cup servings. Big-name companies (like Cuisinart and Mr. Coffee) have been happy to strike licensing deals to put out Keurig-compatible brewers. Retailers are devoting more shelf space to the K-Cup refills. And most of the big names in retail coffee flocked to Green Mountain to show up in K-Cup form. Last year alone saw the introduction of Folgers, Starbucks (SBUX), and Dunkin' Brands (DNKN) as Keurig refills.

Consumers see a growing company. Investors see a different company entirely.

What's really brewing at Green Mountain

Here are just a few things that most owners of Keurig single-serve brewers probably don't know.

  • Patents on the K-Cups expire in September.
  • Starbucks has an espresso-based machine that will also make straight black coffee ready to hit the market this holiday season.
  • Green Mountain missed its own quarterly sales forecast in last week's poorly received quarterly report, lowering its outlook for the balance of this fiscal year as brewer and K-Cup sales are slowing.
  • The company's founder had to rescind his chairmanship after a margin call forced him to sell millions of shares to cover his shortfall, violating the company's trading policy.
  • The stock peaked at $115.98 in September. Just eight months later, the shares are trading in the $20s.

Don't Unplug Your Keurig Just Yet

If you own a Keurig system you don't need to worry. If anything, K-Cups will get cheaper -- and there will be a greater variety of flavors -- after the patents expire.

The problem here for Green Mountain is the patent issue: After the expiration, the company will no longer be collecting a few pennies whenever a K-Cup is sold.

Green Mountain owns many of the popular K-Cup brands. From Timothy's to Gloria Jean's to Tully's, the company has been snapping up some regional brands behind some of the early K-Cup favorites. Only now the company will be competing against cost-shaving private label companies and any other java heavyweights that have been waiting on the sidelines counting the days.

Green Mountain still has patents on the Keurig brewers, but it has always sold them at little to no markup. The model has always been to make it up in K-Cup sales. But with that line of business under threat, suddenly the brewing machine becomes more important.

Attack of the Coffee Machines

Keurig's inexpensive low-water-pressure system has owned the market for years against the fancier appliances. But it's about to get some stiff competition fighting for counter space in your kitchen.

Starbucks shocked the market earlier this year when it revealed that it will put out its own single-serve brewing platform. Verismo won't be a direct competitor to Keurig. It uses high water pressure to serve up fancy espresso and other high-end coffee beverages, similar to Nespresso, Tassimo, Senseo, and CBTL. But Starbucks has a lot of marketing muscle to push this proprietary platform.

Green Mountain isn't standing still. It recently introduced a new brewer -- Vue -- that uses a new refill platform. It's also teaming up with an Italian company to introduce a Verismo-style machine in this country around the same time that Starbucks does before this holiday season.

Green Mountain may be increasing its chances with three different systems, but the confusion may also carve up the market in new ways as Green Mountain shifts its attention away from Keurig once the K-Cup ecosystem changes.



Watching the brew swirl down the drain

Investors have already turned their backs on what had been one of the market's biggest growth stocks for years until peaking late last summer. The stock is trading for just 11 times its projected profitability for this year.

Back in February, Green Mountain was publicly expecting net sales to climb 45% to 50% during the first three months of this calendar year (and the company's fiscal second quarter). But when that failed to happen (net sales instead climbed 37% to $885.1 million during the quarter), it was a dead giveaway to investors that there's something rotten in K-Cup Land.

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How could a typically conservative company be so wrong about its guidance unless sales began to really decelerate during the final two months of the quarter? Brewer and K-Cup sales were lighter than what the company was forecasting, and the company had little choice but to lower its outlook for the fiscal year ending in September.

If investors had a rough time watching the stock shed nearly half of its value on the grim news, imagine being founder and chairman Robert Stiller. He had margin loans and investments backed by Green Mountain shares as collateral. As the stock tanked, Stiller was forced to sell more than a third of his stake to cover the margin call. Another director also suffered a margin call, and both of them will remain on the company's board but in diminished capacities.

The rub is that we don't know if this is last time that Green Mountain will have to revise its outlook lower. There are still uncertainties as to how profitable the company will be after its patents run out. There are also other bearish knocks -- including accounting concerns and a problematic spike in inventory levels -- that Green Mountain will have to address to the market's satisfaction if it wants to earn the trust of investors again.

There is definitely a shot that Green Mountain will bounce back, but it won't be an easy road to redemption.

Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article, except for Green Mountain. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Green Mountain Coffee Roasters and Starbucks. Motley Fool newsletter services have recommended writing covered calls in Starbucks and creating a lurking gator position in Green Mountain Coffee Roasters.

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