David Einhorn Overlooks Improvement At Keurig Green Mountain

| About: Keurig Green (GMCR)


Keurig Green Mountain has a $20 billion market cap and pays a dividend of 0.8%.

In the most recent six months, the company has a 2.6x dividend coverage ratio.

The most current public information indicates Greenlight Capital is short the stock of GMCR. However, the balance sheet strength indicates that this may not be a prudent bet.

The scope of this article will look at the financial health of Keurig Green Mountain (NASDAQ:GMCR) and the ability to continue to pay the dividend. While investors see the current yield of 0.8% as possibly unattractive, the potential for dividend enhancement and the recent investment from Coca-Cola (NYSE:KO) mandates that dividend growth investors give this stock another look.

How Does the Company Earn Money?

GMCR forms relationships with participating brands such as Starbucks and Caribou Coffee. The relationships generally include licensing or manufacturing arrangements.

Under licensing arrangements, GMCR licenses the right to manufacture, distribute and sell the finished products through GMCR's distribution channels using the brand owners' marks. For the right to use a brand owner's mark, GMCR pays a royalty to the brand owner based on GMCR's sales of finished products that contain the brand owner's mark.

Under manufacturing arrangements, GMCR manufactures finished beverage products using raw materials. Once the manufacturing process is complete, GMCR sells the finished product. Under certain manufacturing arrangements, GMCR's sole customer is the brand owner and GMCR is prohibited from selling the beverage products to other types of customers.

How Safe is the Dividend?

Cash flow summary ($ in millions)

Two Quarters

Ended 3/30/14

Cash from operations




Free cash flow


Proceeds from Sale of Common Stock


Repurchase of Common Stock




Click to enlarge

The cash and short term investments at 3/29/2014 were $1.1 billion.

* The company did not pay a dividend in the first quarter.

For the most recent six months, GMCR generated $475 million in free cash flow, or cash from operations minus capex. To calculate the dividend coverage ratio, we must double the dividend and use this as the denominator of the formula. The dividend coverage ratio is the free cash flow over twice the $37 million dividend (to adjust for the lack of a payout in the first quarter), or 2.6x.

For more comparisons on other large cap dividend coverage ratios, see this article on Disney (NYSE:DIS) or this article on Starbucks (NASDAQ:SBUX). Please note that Starbucks had a dividend coverage ratio of 3.3x for the most recent six months of operations, and I concluded that this dividend would be raised in the next couple months.

Cash Conversion Cycle

Given the large amount of receivables and inventory necessary for operations, let's look at how GMCR is performing.

Two Quarters ending 3/29/14

FYE 9/28/13

FYE 9/29/12

Amounts in Millions of $




Sales (Company stores, Licensed stores, Consumer Products)








(A) Days receivables {(Receivables/Sales)*365 days for full year or 182.5 for 1/2 year}

Two Quarters ending 3/29/14

FYE 9/28/13

FYE 9/29/12




Cost of sales and Store Operating Expenses








(B) Days inventory {(Inventory/Cost of Sales)*365 days for full year or 182.5 for 1/2 year}}




Cost of sales and Store Operating Expenses




Accounts payable




(C) Payable Days {(Payables/Cost of Sales)*365 days for full year or 182.5 for 1/2 year}}




Cash conversion cycle {a+b-c}

Click to enlarge

The cash conversion cycle is the amount of time between a company spending cash and receiving cash per each sale. It is a measure of efficiency, and how long cash is tied up in working capital. The CCC is a great way to analyze the efficiency of the organization in managing cash to generate more sales.

In FY 2013, GMCR held inventory for 90 days plus 39 days to collect receivables or 129 days in total. GMCR pays accounts payable in 42 days, thus achieving a 88 day cash conversion cycle. For an explanation of how cash conversion can identify a business with a strong business moat, see this illuminating article on AMZN. Unfortunately, GMCR is not able to dictate to terms to the extent that AMZN can, but this does not mean that the core business of GMCR is weak. In fact, the above chart shows the core business improving.

Please note that the intention of this article is not to compare AMZN and GMCR. The above is mentioned to illustrate the strength of a business model, and how suppliers can fund operations, much like a bank or an equity investor.

New Product Pipeline

Keurig has several new products in the pipeline, including Keurig 2.0, which will replace both the current Keurig and Vue platforms, and Keurig Cold, which is a partnership with Coca-Cola. Likewise, GMCR plans international expansion, as the company now primarily operates in Canada and the United States.

Since its K-Cup patents expired in 2012, GMCR has seen cheaper, off-label pods take a 14 percent market share. Keurig will roll out a version 2.0 of its brewing machine this fall that uses bar code scanners to verify that pods are properly licensed. Keurig 2.0 will be introduced in late 2014. Interactive technology will prevent unlicensed portion packs from accessing the 2.0 platform, which should put a lid on unlicensed brand market share. However, there seems to be little incentive for existing Keurig users to upgrade to the new machine.

As for Keurig Cold, an important point in Keurig's favor is that SodaStream's (NASDAQ:SODA) household penetration in the U.S. is only slightly over 1%. However, in other respects, Keurig Cool would seem to be at a disadvantage. The new GMCR machine is likely to be priced higher than those of SODA, and the new GMCR system will provide only a single-serving pod, whereas SODA provides one-liter and two-liter sizes.

David Einhorn and the Greenlight Short of GMCR Stock

According to a third quarter 2013 investor letter, Greenlight Capital is still short this stock. I'm certain that Einhorn has thoroughly researched the most recent Q2 financials for GMCR. In that investor letter, Einhorn suggested that the market is saturated for Keurig brewers, the market is becoming commoditized and that Keurig's market share is shrinking.

Another short, Whitney Tilson, the founder of hedge fund Kase Capital Management, wrote in an e-mail to Bloomberg that he was "shorting it because I think the company's top- and bottom-line growth will continue to decline (and may even begin to shrink) as generic K-Cup competitors continue to take market share and cut prices."

A Healthy Income Statement

Two Quarters ending 3/29/14

Two Quarters ending 3/30/13

Net sales



Gross profit



Operating income






Net income



Click to enlarge

Given the above percentages, I fail to see how this business is becoming commoditized to threaten the viability of GMCR's business. I contend that Mr. Einhorn, if he is still short the stock as of 6/19/2014, must be hoping for earnings multiple compression.


I conclude that the GMCR dividend is safe for 2014 and into 2015, primarily due to the high dividend coverage ratio and the seal of approval from the M&A team at Coca-Cola.

GMCR trades at a large premium to the S&P 500. The trailing P/E ratio is about 37x compared to an S&P 500 index trading at almost 18x. Also, note that GMCR has a below market dividend yield of 0.8% compared to an S&P 500 dividend yield of 1.7%. Due to the strength of the operating results and the capacity to raise the dividend, I would not be short this stock. Investors may be willing to pay a premium for stocks with capacity for dividend increases.

This article did not cover the significant risks that GMCR will face as they continue to expand into cold beverages and the 2.0 system. Both of these ventures may require substantial capex, and this could strain the dividend.

Likewise, this article did not discuss the strategic relationships for the manufacturing, distribution, and sale of portion pack products with companies such as Caribou, Dunkin' Brands, The J.M. Smucker Company, and Starbucks. If GMCR is unable to provide a combination of pricing, marketing and advertising support, or if strategic partners are not satisfied with brand innovation, they may act to hurt the growth and awareness of the Keurig systems.

The above article is an opinion, and not investment counsel.

Disclosure: The author is long WMT, DIS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.