Green Mountain Still Has Upside Even After Its Patent Expiration

Any news on increased competition or limited top-line growth for Green Mountain Coffee Roasters Inc (NASDAQ:GMCR) is often met with an overreaction. As such, the market is anxiously waiting for the latest earnings which might provide some clues on the company’s outlook in the coming years.

We believe the current stock price reflects pessimism around the company’s outlook as evidenced by its stock falling from $108 August last year to around $23 currently. We believe the market often undervalues the fact that this is a company which offers quality products, has satisfied customers, and has the capability of churning out decent profits each year, which ultimately support our near $30 price estimate.

See our full analysis of GMCR here

Brewers to Contribute More

We expect a structural change in the way the company earns profits. Earlier, the Keurig brewers were sold at cost price or sometimes even at a loss and most of the company’s profits were derived through the sale of Green Mountain K-cups. Any third party which sold its K-cups had to pay a royalty to Green Mountain. Now that some of its patents have expired, any company is free to roll out its own K-cups without being bound by an obligation to pay royalty to Green Mountain.

Not only will Green Mountain lose out on this exclusivity, but increased competition from new entrants will probably eat up the company’s market share in K-cups as well. Nonetheless, this might be the right time to buy a Keurig K-cup brewer. After all, no other brewer is as compatible with the vast number of brands and coffees (and even iced teas) as Keurig single cup brewers are. Presently, K-cups are available in more than 200 different varieties under 25 different brands.

That figure will rise even further as new entrants launch their own K-cups. Customers of Verismo will only be limited to the coffee offered by Starbucks. Similar is the case with Nespresso. Thus, the Keurig brewer has a distinct advantage over its competition. Further, we wouldn’t be surprised if coffee-at-home becomes a greater part of an American consumer’s lifestyle.

A greater choice also blends well with GMCR’s away-from-home segment that mainly targets offices. Since a single coffee brewer serves many people in an office, it makes sense to have a Keurig brewer, which is compatible with a variety of brands, rather than a Starbucks brewer which only serves a single brand.

Newer, More Niche Brewers

It is also important to note the technological differences between Keurig K-cup brewers and brewers offered by competitors. Starbucks’ Verismo uses a high-pressure system and is primarily used for making specialty beverages such as latte and espresso. Similarly, Nespresso, as the name suggests, is primarily used for making espresso. Keurig K-cup brewers, on the other hand, use a low pressure system and are primarily used for preparing non-espresso coffee and tea.

With Keurig Vue brewers launched earlier in the year, Green Mountain has stepped up its presence in specialty drinks (such as espresso and latte). It is also developing high pressure brewers with Italian giant Lavazza which will see it competing directly against Nestle’s Nespresso and Starbucks’ Verismo. Thus, going forward, sale of brewers will contribute a greater deal to its profits. Green Mountain’s average revenue per brewer is likely to show healthy growth as the company adds new and more expensive brewers to its line-up. Vue, for example, is priced more than $200 while the traditional K-cup brewers are available for less than $100.

In addition, only 2 out of a total 38 patents that Keurig possesses expire in September. While it is okay for any company to introduce its own K-cups, it still can’t roll out its own brewers using a technology similar to Keurig K-cup system. If it does, it is likely to face a litigation battle against Green Mountain over patent infringement.

And supporting all this is the fact that Keurig brewers have received good reviews time and again. They brew good coffee and are hassle-free. Green Mountain’s customer service is good too. Customers who buy K-cup brewers and recommend it to their friends and families do so because they are satisfied with the product. We believe that the growing product line-up and solid reputation will help the company immensely in the future.

We have a $29 price estimate for Green Mountain Coffee Roasters, which is about 30% above the current market price.

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