Increased Portion Pack Prices By Keurig Green Mountain Might Not Affect Consumer Consumption Rate

On August 14, the Vermont based K-Cups maker, Keurig Green Mountain (NASDAQ:GMCR) announced that it is raising prices by nearly 9% on all its single-serve portion packs and other traditional bagged, fractional packs and bulk coffee products, with effect from November 3, 2014. ^[1] The company had kept its portion packs’ prices subdued for a long time, even when the competing coffee companies such as Dunkin’ Brands(NASDAQ: DNKN), Peet’s Coffee and Starbucks Corporation (NASDAQ:SBUX), as well as coffee retail chains such as Kraft Foods Group (NASDAQ:KRFT), raised their prices a couple of months back.

The company mentions its price increase to be a direct result of increasing price of green coffee and cocoa, as well as rising costs of packaging materials, energy and transportation charges. Since January, the prices of green coffee rose nearly 60%. ^[2] Although the prices dropped down in the month of June, they are back on the rising trend. Moreover, the company has locked its entire coffee supply for 2014 and are 75% hedged for 2015, as mentioned in its latest quarterly earnings call transcript. ^[3] However, the coffee’s bullish trend seems to continue, primarily due to prolonged drought in Brazil. According to the National Coffee Council, production in Brazil, world’s top coffee producing nation, may drop 18% year-over-year to 40.1 million bags when the harvest comes next month. ^[4] Earlier this year, experts estimated global demand for coffee to be nearly 146 million bags, which might outpace supple by 7 million bags and might drive the price of Arabica beans to $3 per lb. ^[5]

See our full analysis of GMCR here

In a competitive industry such as coffee, input costs makes a lot of difference to a company’s overall growth. Companies such as Starbucks, Dunkin’ Donuts and Peet’s Coffee have already announced the coffee price hike, due to sustained increase in the input costs. (see Starbucks raises coffee prices : Boost to margins and revenue growth) Finally, Keurig Green Mountain decided to raise its portion pack prices, but the company is aware of the fact that consumers might shift to cheaper beverage options. However, to protect their customer base the company has taken some impactful measures:

• Keurig 2.0- the new improved brewer- has been recently released in the market
• Over the last six months, Keurig has entered into several distribution deals with some of the top retail chains and coffee brands, with the motive of accelerating its top line growth

Distribution Deals With Major Coffee Brands

Keurig Green Mountain has accelerated its pace in joining hands with major coffee brands and other retail chains such as Dunkin’ Brands (NASDAQ: DNKN), Peet’s Coffee, Starbucks Corporation (NASDAQ:SBUX), Nestle U.S. division and  Kraft Foods Group (NASDAQ:KRFT). These deals give the company an upper hand in the industry to widen its market share in the single-serve coffee segment. These brands constitute 75% of the total U.S. coffee consumption and have a huge customer base. Customers who like Maxwell House’s coffee, Starbucks’ premium coffee taste, Nestle’s creamer with their coffee or Dunkin’ Donuts coffee, inspite of going to the respective coffee outlets to get a cup would rather buy portion packs and enjoy their favourite cup of coffee at home. Thus, entering into partnership with the coffee giants will ensure that the customers owning the Keurig brewers will not be restricted to limited options. The Keurig consumers will now have options to select their favorite coffee brands, ensuring that the company sustains its loyal customer base. Moreover, a selective group of people, who does not own Keurig brewers and prefer convenience, might buy the new technology. In short, the timing of the price hike would not have been better, as the distribution deals might ensure the loyalty of its existing customer base. We have discussed the reasons and impact of these deals in detail in our prior article. (see Distribution Deals With Major Coffee Brands To Help Keurig Green Mountain Gain Market Share)

Keurig 2.0 To Attract More Customers

On the other hand, the company released its most awaited product of the year- Keurig 2.0. ^[6]  The timing could have been better, considering the distribution deals have attracted majority of the coffee lover’s interest in the portion packs. With Keurig 1.0 getting outdated and Keurig 2.0 offering numerous advantages over any of the previous editions, people with any interest in the company’s brewer might buy the newer improved version. This will not only increase the brewer sales, but will ensure the company’s dominance in the single-serve market as well.

In short, Keurig Green Mountain’s decision to raise the price of its portion packs not only feels justified, but a well-planned move to sustain its customer base. If the company is successful with its plan, it might boost net revenues of the company without harming the customer base.

Trefis estimates the average price of portion-packs in 2013 to be nearly 33 cents and estimated the price to rise to 34.5 cents by the end of 2014. This price rise of 1.5 cents per portion packs included higher priced creamer added portion packs, as well as other K-carafe packs and excluded any price hike due to rising input costs. With the price hike of 9% coming into effect from November, the effective price estimated at the end of 2014 comes down to 35 cents per portion pack and 37.6 cents per portion pack in 2015. As a result, Portion pack revenues are estimated to rise by 26% year-over year by the end of 2014 and will lead to a 3% upside to our valuation for the company.

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1. Keurig Green Mountain announces price increase effective November 3, 2014 [↩]
2. Coffee, ICE December 2014 futures [↩]
3. Keurig Green Mountain earnings call transcript, Q3 2014 [↩]
4. Brazil coffee output set for longest decline since 1965 [↩]
5. Drought in Brazil drives the price of coffee beans to a record high [↩]
6. Next Generation Keurig 2.0 now available [↩]