Exploration 20 Dog Days of Summer Research: Keurig Green Mountain

Single-serve coffee brewing systems, once thought to be a novelty that would never catch on, now make up a staggering quarter of every dollar American’s spend on coffee. According to research firm Mintel, by 2018, it is estimated that this number will double again and consumers will spend as much on single serve pods as they do on bulk coffee grounds. Investors would be foolish (and not the good kind) to not take advantage of this tectonic shift, and for those that believe in the future of single-serve brewing systems there is only one name: Keurig Green Mountain (GMCR.DL).

A Coffee Chain Buys a Single Serve Brewing System
Keurig Green Mountain’s history starts in the (surprise!) Green Mountains ski resort region of upstate Vermont. There, company founder Bob Stiller came across a cup of coffee so good that he bought the distributor that sold the beans with two partners and began distributing the roasted beans to restaurants, gas stations, retailers (like LL Bean and Staples), and grocery stores. As the years went by Americans developed a taste for premium coffee and the Green Mountain Coffee Company grew by leaps and bounds.

Keurig® K45 Elite Brewing System Source: Keurig.com

Green Mountain would have remained a simple roasted coffee been retailer and distributor had it not been for one fateful day when 3 MIT students took a new invention to the company looking for an investment: The Keurig. Green Mountain invested in the startup in 1993, only to increase its ownership stake as time went on only to buy the entire Keurig company 2006. It was in this year that things really took off, as the combination of a premium bean distributor and a dynamic new technology proved as dynamic as rocket fuel. All results in millions unless otherwise specified:

Source: S&P Capital IQ

While the Keurig machine itself was revolutionary, the real money for Keurig Green Mountain was in the single serve coffee pods themselves. Similar to the highly profitable business model of Gillette, where the company sells consumers a razor and disposable blades that need to be replaced on a regular basis, Keurig generated staggering profits from pod sales - not the actual machines themselves. In recent years, pod sales have made up over 84% of the company's total revenue, while sales of the actual machines and other products made up the balance. 

Unfortunately, success tends to breed imitators and now it seems that Keurig Green Mountain is being attacked from all quarters.

Recent results
To say that GMCR has experienced a reversal of fortune over the last 12 months would be an understatement. Shares peaked last November at $158 a share and have since fallen to just above $50 at the time of this writing. On August 5, 2015 investors got their latest glimpse into the company's business and the prognosis was not good:

• YoY Net Sales Decrease of 5%
• YoY 22% decrease in diluted EPS to $0.73
• 1% decrease in Pod Net Sales, even after factoring in volume growth of 5%
• 26% decrease in Keurig Brewers and accessories Net Sales

During GMCR's quarterly conference call, President and CEO Brian Kelley noted that the company was not pleased with its lack of revenue growth but noted that the company was taking decisive actions to tackle with its current headwinds. In addition, the company announced a $1 billion dollar share buyback and a cost savings initiative. Despite management's statements, the stock fell as much as 28% following the release, particularly because the Keurig is simply realizing less revenue per pod than it used to thanks to increasing competition. This is forcing the company to adapt and broaden its offering in order to survive in an increasingly competitive market place.

Future Growth Initiatives
Keurig Green Mountain has a two pronged approach to reignite growth going forward: a new model of its Keurig single-serve coffee maker, the Keurig 2.0, and a brand new product set to hit the market later this year in limited quantities, the Keurig Kold, in partnership with Coca-Cola. The preliminary verdict is in on the first of these two inititiaves and unfortunately it is not good. Not only did sales of new machines drop precipitously in the recently completed quarter, but attempts by the company to ensure use of its own pods (as opposed to pods sold by competitors) in the new model were met with disdain by consumers. The company put on a good face regarding the launch, stating in its latest quarterly conference call that "We are encouraged by the launch of our K200 line, our entry-level reservoir 2.0 brewer, which is off to a good start with positive reviews from consumers and good feedback from retailers." Unfortunately this optimism couldn't hide the fact that during the quarterly GMCR took a $18 million dollar charge due to lower than anticipated sales of the 2.0 line. This is not to say that the company does not have a decent basic business predicated on its single-serve Keurig machines, as seen in a recent investor presentation:

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Source: Keurig Green Mountain Investor Presentation

The simple fact that there are 20 million Keurig machines in the United States should give investors hope that all is not lost, but in order to generate growth Keurig's management, and shareholders, are betting it all on the Keurig Kold. Make no mistake, Keurig Green Mountain faces long odds and the attempt amounts to somewhat of a "Hail Mary pass." Another Motley Fool Rule Breakers former pick, SodaStream (SODA), has been attempting to crack the in home cold beverage U.S. Market for years to no avail. The parallels between Keurig Green Mountain and SodaStream are eerie. Soda Stream boasts a highly profitable European carbonated water business which serves as the company's cash cow. GMCR, as noted, still generates solid profits with its in-home coffee system, and is attempting to succeed where Soda Stream failed - cold carbonated in-home beverages. 

Keeping it Kold
America's premiere beverage brand, Coca-Cola, clearly sees something in Keurig Green Mountain. In February 2014, the soda giant shocked the world by investing $1.25 billion for a 10% stake in GMCR, only to up that stake to 16.8% via open market purchases. Since then Coke has worked with GMCR to develope the Kold beverage system, which will allow consumers to create their own single-serve glasses of coca-cola in the home the same way they brew coffee with the Keurig. We don't yet know what the consumer response to this will be, as the Kold won't hit the market in limited channels until later in 2015. However, the market potential is huge:

It will likely be over a year before we know if the Keurig Kold has any legs, but it should be noted that the machine is being priced at a minimum of $299 and each pod will likely run the consumer $0.99. Simply put, the Kold is a pricey option for the average consumer (especially compared to Soda Stream's base model which starts at $79.99) and investors should take this fact into account. 

Foolish Bottom Line
Once high-flying Keurig Green Mountain still has a solid business, supported by over 20 million machines in the United States. Each one requires a new pod each and every time a consumer desires a cup of coffee. However, the days of high growth appear to be over - due to price competition and possible market saturation. While the company has high hopes for the Kold, supported through its partnership with Coca-Cola, it seems likely that the company will face consumer adoption headwinds due to the Kold's hefty price tag and the difficulties that fellow beverage-system trailer blazer Soda Stream experienced when trying to break into the U.S. cold-beverage market. That being said, should Keurig Green Mountain figure out how to get consumers on board, the company may very well have years of dynamic growth ahead of it.