In an attempt to get ahead of the Green Mountain Coffee Roasters (GMCR) Analyst/Investor Day vent held on September 10, 2013, Capital Ladder Advisory Group offered investors a preview of insights to help identify some key points of relevance when listening to the GMCR presentation. Capital Ladder had the fortunate opportunity of covering the Analyst/Investor Day event for our clients and investor group and this article will aim to disseminate some of our thoughts and upfront analysis regarding the GMCR presentation. Unfortunately, during this latest GMCR article offering, we are not inclined to offer any channel sales data that we have recently achieved through our extensive network of retailers, but if you would like the opportunity to see a later dated Vue 700 channel sales representation simply click on a previous article we outlined for investors.
Since we have already mentioned the Vue 700 platform brewer system, let us start there and carry forward with Green Mountain's intentions to launch adjacent beverage category brewer platforms. It has long since been the opinion of Capital Ladder Advisory Group that the Vue platform was a poorly planned, researched and designed platform. At the International Home & Housewares Show in Chicago in 2012, I had the opportunity to speak with Green Mountain executives and designers as they begin debuting and demonstrating the Vue platform for a multitude of retail buyers. My key concern with the platform at that time was that the platform was not backward compatible and the price point seemed to tip the product into a product category that would not enable Green Mountain to maximize the rate of return on investment. Essentially, I felt the brewer bordered on entering into the specialty small appliance category given the $200+ price tag, limited inventory building opportunity and that these consumer goods qualities would only garner sales akin to other specialty small appliances. Unfortunately, I have been proven most accurate with these points of analysis as is clearly identified in the channel sales data presented by GMCR more than a full year after the launch of the Vue 700 and more appropriately priced Vue 500 brewers. A further validation of this analysis has been proven by Brian Kelley during the Analyst/Investor Day presentation when he noted that some of the lessons learned from the Vue platform were that the system was not backward compatible and needed to carry with it a greater variety of V-pack offerings. But I digress so let's discuss where the Vue platform goes from here.
During the Analyst/Investor Day presentation GMCR outlined several product innovations the company plans to develop and roll-out to customers over the next couple of years; the Keurig 2.0 is one of these intended product innovations. Keurig 2.0 is a blending of the Keurig platform brewer system with the Vue platform brewer system. The company plans to take the best form, fit and functionalities of the two operating platforms and combine them into one singular brewer platform named Keurig 2.0. The Keurig 2.0 will be backward compatible, use RFID technology, simplify the user interface and have recyclable K-cups. In naming the system Keurig instead of Vue, I think this only further points to the company's steering away from the Vue product focus as a whole and leaning more heavily on its abundant Keurig user base than its much smaller Vue user base. For those Keurig users who never "upgraded" to the Vue platform, they might be more inclined to purchase a new and enhanced brewer with the brand name Keurig. In this regard, I think GMCR is showing some difference in intelligent leadership which may not have been so apparent under the former CEO, Larry Blanford. So with that said, "Kudos Brian Kelley (Newer GMCR CEO), kudos".
The Keurig 2.0 is not set to launch in retail establishments until late 2014-early 2015 time period, but more than likely GMCR will debut and demonstrate the new brewer system and other product initiatives at the March 2014 International Home & Housewares Show in Chicago, Illinois where Capital Ladder Advisory Group is a regular attendee. Now let's move on to the other product initiatives GMCR plans to develop and launch in the next 12-15 months.
In total, Green Mountain is dedicated to creating four brewer systems which are as follows: 1. Hot 2. Cold. 3. Water 4. Specialty (2016). Within the confines of each brewer system there will be new partners and multiple platforms designed to appeal to a wide array of consumers. These systems will continue to develop and launch periodically over the next three years.
One of the biggest beverage categories GMCR plans to get into in a more broad way during fiscal 2015 (begins October 2014) is the Cold Beverage category. The company plans to launch both a water brewer and a cold brewer platform during this time. Brian Kelley stated that the cold beverage category is five times larger than the hot beverage category. Neither the water brewer nor cold brewer platforms were discussed with much detail other than to note brief specifics of the opportunities that these two brewers within the cold beverage category present great opportunities for growth and that the company's consumer research indicates strong demand for such brewer systems. Unfortunately, representations of these brewer systems were not on sight at the Analyst/Investor Day event, but pictures can be viewed of the potential machine dynamics from the company's webcast of the event. So let's get into what Green Mountain has to successfully accomplish with the cold beverage platforms.
With Capital Ladder specializing in the consumer goods/retail sector, we tend to have a strong grasp on what it takes to launch a successful product and maintain a level of success over time. The cold beverage category through a brewer system at-home, first and foremost, requires a cost benefit analysis. In other words, the system has to provide some economic benefit to the consumer. In all GMCR platforms to date, the company has not been able to produce such a benefit to the consumer as the company has not the necessity to do so. You see, the hot beverage platform is about convenience for the consumer. It has proven to be more convenient for a consumer to pop in a K-cup, at home, even if it costs a few more cents rather than to wait on line at Starbucks (SBUX), Dunkin Donuts (DNKN) and/or McDonald's (MCD). With that said, the cold beverage category already has convenience built in as cold beverages are at the fingertip and on-demand wherever and whenever the consumer wants. GMCR has never been called upon to show an economic value to the consumer in any of its products which it will decisively have to do in the cold beverage category. I have laid claim to this point of analysis regarding the cold beverage category and GMCR in the past. GMCR's CEO validated this point at the Analyst/ Investor Day event when he cited the need to show economic value for the cold beverage platforms. The price sensitivity of the cold beverage category becomes even greater for carbonated soft drink which is another application of the cold beverage platform the company aims to develop.
The cost of carbonated soft drinks is ever-increasing, but seemingly still affordable with regular sales and a variety of off-brand participant in the category. With GMCR operating at a premium cost/cup of coffee, the company will need to offer the consumer a carbonated beverage platform that effectively demonstrates a closely comparable cost structure to the average $1.18/2-liter bottle of carbonated soft drink year round. SodaStream (SODA) currently dominates the at-home CSD category with a host of platforms and a closely comparable cost structure to name brand and off-brand CSD providers and could be a potential partner with GMCR in this category going forward. The most difficult aspect of offering at-home CSD is the application of CO2. When Brian Kelley was asked about the application of CO2 at the Analyst/Investor Day event, he only offered that they will be able to effectively do so and that all beverage platforms will take on partnerships where and when it is necessary. Off-stage and during breaks from the presentation, Kelley was asked if the company has a working model/proto-type of a carbonated soft drink brewer and he said they hope to have one available for customers to purchase during fiscal 2015, but wouldn't comment further.
With a host of new brewer systems outlined for development over the next three years, investors have much to look forward to as the quarters commence and complete going forward. The next development to commence in 2014 will be the international expansion of the Keurig system. Green Mountain outlined its plans to expand into several countries over the next few years with four high-priority countries slated for 2014. South Korea, the United Kingdom, Australia and Sweden are on the list of international expansion opportunities next year and this expansion will be accompanied by a new Keurig brewer designed especially for these markets and in a host of different colors and style formats. With regards to these specific regions, Brian Kelley noted that Australia has the highest priced brewer systems in the world at $375, the average Swede drinks 6 cups of coffee/day and the United Kingdom is the 8th largest coffee market in the world. Depending upon the degree of success with these expansionary efforts, the company could expand further into markets such as Brazil, Mexico, Japan, Poland, Turkey, South Africa and Singapore. Of most importance to investors and with consideration of expansion, Brian Kelley noted the following: "This will not represent immediate, large growth, but overtime if less than 2% of households in the top 10 target countries adopt Keurig brewers this will represent 8 million households and roughly 10-15% of revenues by 2020". This is a pretty good outlook, if all goes accordingly.
Green Mountain is not limited to international expansion or at-home expansion, but rather with its new Keurig Bolt brewer system the company will be expanding beyond the at-home channel and into the food service and hospitality business. The company already has a presence in this more commercial industry, but the technology and convenience of the Bolt system will allow the company to grow into this segment of the market in a larger way. The away-from-home segment represents 19% of Green Mountain's total revenues currently, but the company hopes to grow this away-from-home business into the low 20% range by next year.
In the United States, while retail distribution is largely saturated at this point and which is identified through the company's quarterly slides indicating market penetration per region, the company still has opportunities to grow its user base in specific regions around the United States. The regions Green Mountain aims to target are Madison, Los Angeles, Miami, Atlanta, Chicago and Greensboro. Green Mountain aims to target the consumer in these markets by holistically marketing to the consumer through television, social media, sampling events and local ad sites. If investors are looking at the company's potential opportunity to grow in the United States they need only to look at the current market penetration rate in the northeast. The northeast still represents the company's highest market penetration rate at roughly 19.5%, but the South, as a whole, only represents a market penetration rate of roughly 9% which outlines the potential for growth in the southern region for Green Mountain. Keep in mind these markets are highly price sensitive, in part, due to the population demographics as well as economic demographics.
One near term marketing strategy the company will employ to grow in these specific markets outlined by the company is through the "Brew The Love" commercial advertising campaign. Additionally, the company is going to drop 5,000 brewers on the door steps of potential Keurig customers free of charge to engage these potential customers and introduce them to the Keurig brand.
From an investor's standpoint, what has to be considered under the topic of expansion is cost. As Green Mountain enters the maturation phase of its North America business cycle, it is clear that going forward the cost per consumer acquisition will only increase. This is clearly evidenced by the working capital being presented in the company's strategy to grow its market share and penetration rate in the United States. Subsequently, an investor has to weigh and model the likelihood of gross margin contraction in 2014 due to these expansionary efforts. At this time, and with little more than an outlined plan, this may be a difficult exercise to engage in, but that is the job of an analyst and several analyst reports have noted the potential for a minimum of a 50 bps gross margin impact due to expansion costs in 2014 which may be mitigated by operational cost savings leverage. In spite of some analysts' opinions, GMCR has offered an update in terms of guiding to 2014 gross margins and operating margins. At the Analyst/Investor Day event the company stated it expects to improve gross margins and operating margins by 100bps in 2014. Among the potential factors impacting this gross margin forecast is the potential need for distribution partnerships related to international expansion. Again, when questioned off-stage about the need for distributors, GMCR officials said, "We have considered the need and will discuss the subject further if the business warrants it". It is unlikely that Green Mountain will enter some of the international markets outlined without the partnership of well-established distributors in certain regions which will impact the profit structure of the business in a negative way. This is not necessarily a bad thing if your wholly owned markets are expanding gross margins.
Green Mountain's Analyst/Investor Day offered investors a good deal of information about the company's past, present and future business. Unfortunately, what it also left investors with is a gap between the potential from beneficial regional and product expansions for 2014 and the next two quarters. With the company's Q4 coming to a close, the retail ordering cycle seems to be coming in lighter than a year ago, but with a consistently growing user base the typical holiday ordering cycle could be extended beyond the September 30th deadline due to economic uncertainty and the need to meet the demands of the consumer. GMCR officials seemed quite confident regarding the results it's seeing in the sales channel during its presentation; we'll see if it materializes in the final results.
Just ahead of the Analyst/Investor Day event, a somewhat scathing article surfaced from the New York Times and I'd like to take a little time to evaluate the content of the report which lays claim to the potential for misreported sales from GMCR. Within the article, the author asks the question, "How wide is the gap between how many K-Cups the company says it has sold and how many have ended up in customer's hands? And why?"
The question the author raises is contextually important to understand. With that said let's further break down the question to its key components and then outline it's definitions for investors. First, it is important to understand that in 91% of all sales transactions GMCR is not selling directly to the consumer as only 9% of sales are generated through its direct-to-consumer e-commerce business. The other 91% of sales transactions are conducted through distributors and retailer partners. These sales are called sell-in sales transactions in that the company is selling to a distribution partner or retail partner; they are not selling to the consumer/end user. Only these sales, in conjunction with e-commerce sales, are recorded by GMCR as sell-in sales. This is where the author's use of the word customer becomes tricky because the distribution partner, retail partner and consumer are all customers. Having said that, only sales transactions recorded with GMCR, distributors, retail partners and e-commerce direct sales are recorded as sales even if in the case of distribution and retail sales transaction the end user/consumer hasn't yet bought a K-cup or brewer from them. All the aforementioned information is called sell-in sales and only sell-in sales are recordable as actual sales transactions by GMCR. So it is important to understand that not all sales are sell-in sales and as mentioned above, in 91% of the transactions, the consumer/end user is not involved in a sales transaction. With that said, since we have identified what GMCR actually recognizes and records as a sell-in sale, let's identify what is a non-recordable sell-out sale. This is very simple as most of you have probably identified by now; a sell-out sale is a sales transaction from a distributor to a retailer or a retailer to a consumer/end user. Once a product leaves GMCR's hands through a sell-in transaction to a distributor or retail partner, the inventory is out of GMCR's hands and selling the product to the consumer is left mostly to the devices of these partners.
I'm going to have to assume that Jesse Eisenberg, author of the New York Times article, hasn't fully recognized and/or understood the information stated above because if he had he would recognize that while there is a gap in sales still yet to be reconciled by GMCR, it is nowhere near the 700 million he cites in his well-articulated article. Capital Ladder fully recognizes the assertions made by Jesse Eisenberg as poignant and of concern, just not to the degree his understanding of recordable sales are as defined under the rules of the SEC and with recognition of GMCR's distribution and retail partners.
In Mr. Eisenberg's article, he cites and utilizes data provided to him by sales tracking company IRI. While he does mention that IRI only has access to roughly 55% of GMCR's total sales data, he doesn't mention or articulate that the data from IRI is largely point-of-sale data, otherwise known as (drum roll)…sell-out data . So what IRI is actually capturing in the way of sales data is the consumer/end user results and not necessarily the recordable sales by GMCR. So let's move on to the final discovery phase of analyzing Mr. Eisneberg's article.
In order to meet the consumer's/end user's demand, a retail partner has to not only have enough product on the shelf to meet sales forecast, but also enough to replenish daily sales and meet the sales trend. In the case of K-cups, the sales trend is up double digits year-over-year. So the thoughtful analysis would serve to prove that distribution and retail partners have bountiful more inventory of product than what is actually sold to the consumer to ensure well-stocked shelves to meet the ever-increasing K-cup demand. This brings us to one of the biggest and most evidenced displays of this inventory build by a singular retail partner for GMCR. Bed Bath and Beyond (BBBY) is arguably GMCR's largest sell-in retail partner. I know most would think that Wal-Mart (WMT) is the firm's biggest retail partner, but take a look around your local Bed Bath and Beyond retail store and take a look at GMCR's webcast which presents a slide from a BBBY store and how the product is presented in the BBBY store. If you walk into any BBBY store you are almost bombarded with GMCR products from shelf to ceiling as the company is very unique in the way it presents its merchandise to the consumer. Bed Bath and Beyond typically orders product to fulfill 8 weeks of current trend sales for most items. In the case of Keurig and other GMCR related products, it tends to order and hold in inventory around 12 weeks of inventory. The company does this for a couple of important reasons. First, BBBY maintains the largest variety of K-cups (90+) for the consumer to choose from on a daily basis so as to set itself apart from other retailers. Secondly, the company's merchandising strategy features inventory on the sales floor, but not accessible to the consumer without the assistance of a BBBY sales associate. Capital Ladder Advisory Group has noted in the past the nature of GMCR's relationship with BBBY in the past and it appears that this relationship is still widely misrepresented in the way of sell-in and interpreted sell-out data. With all the data taken into consideration, and as noted previously in this article, there still remains a gap in K-cup sales recognized by Capital Ladder Advisory Group. However, akin to recognizing this particular relationship between BBBY and GMCR, we would feel comfortable suggesting at least one similar relationship showing high levels of inventory exists with another GMCR partner constituting the difference between sell-in and sell-out data. I guess the real question is why didn't GMCR explain this to Mr. Eisenberg? The answer is probably because it doesn't have to and, as stated earlier, there is a gap that warrants reconciliation by GMCR but it would require more specific data dissemination to the market than GMCR is presently comfortable with offering. After what happened to the share price from 2011-2012, who can blame them?
The fact remains that a retailer should always have more inventory than sales so it can continue to generate sales. The gap between sell-in and sell-out is present in every single CPG company, unless of course the company's products are failing to achieve sales expectations. Here I thought this was common knowledge.
Capital Ladder Advisory Group maintains a Hold rating on shares of GMCR. With GMCR outlining its prospects for the future and its probability for success regarding its international growth strategy investors might consider near to mid-term weakness in share price a reasonable opportunity to explore initiating scaled positions in shares of GMCR. Near term share price catalysts could include announcements surround acquisition or partnership agreements reached with food service industry providers and/or unlicensed single-serve coffee providers. Consumer Spending, Retail Sales and political events could be near term hurdles for shares of GMCR to overcome.