Green Mountain Coffee Roasters (GMCR) is scheduled to announce earnings on Aug. 7. Shares of the company soared after the previous earnings release but have traded in a narrow range since. Besides raising the earnings guidance, the fact that Green Mountain was able to extend its partnership with Starbucks for another five years cheered the market. For fiscal 2013, the company now expects a profit of $3.05 to $3.15 a share, or 31% to 35% more than the previous year figure on sales growth of 11% to 14%.
Can K-Cup Volumes Be Sustained?
It was widely expected that Green Mountain's K-Cup sales would slow down with the influx of cheaper private labels. But the company has done remarkably well, with unit sales growing 26% in each of the two quarters this fiscal year. Two of Green Mountain’s patents expired in September last year, which opened the doors for private labels to introduce their own K-Cups without having any obligation to pay royalty to the company.
On the other hand, there could be some deterioration in the pricing, which is not unreasonable to expect since the competition has increased. We expect the average revenue per K-Cup to decline by about 3%-4% in 2013. Overall, the company has done pretty well to balance the volumes vs. pricing of its K-Cups. Strong K-Cup sales growth is critical to the company's profitability since it derives most of the profits from the sale of the coffee pods. The brewers are sold at very low margins in order to boost the adoption rate.
It will be interesting to see how this quarter pans out in terms of brewer volumes. Keurig brewer volumes tanked 9% on a year-over-year basis in the previous quarter, and a continual decline in its volume doesn't bode well for the long-term prospects of the company. After all, you could argue that the higher the number of brewers sold, the higher the number of coffee pods that are likely to be sold.
Margins to Widen
In the near to medium term, Green Mountain will benefit from low coffee prices. The company's most important raw material -- namely Arabica coffee -- is trading near a three-and-a-half-year low. Therefore, we expect the gross margins to witness some improvement on account of subdued raw material costs.
Although the gross margins may exceed 40% like they did in the previous quarter, full year margins are likely to be lower. This is because brewer sales tend to be seasonal and typically swell during the onset of the winters. Brewer sales will account for a greater proportion of the total sales in the full-year income statement than they will in the upcoming quarter. As already mentioned, brewer margins tend to be lower than the K-Cup margins.
For 2013, we expect the margins to expand by about 180 basis points. A full percentage change in the gross margins causes a change of about 10% to our valuation. We now have a $66 price estimate for Green Mountain Coffee Roast, which is about 10% lower than the market price.
Disclosure: No positions.