Green Mountain Valuation Is Excessive

Aug. 7.14 | About: Keurig Green (GMCR)

Summary

Green Mountain reported mixed quarterly results, and at this valuation, it would be wise to sell shares.

Price cuts hurt revenue growth, and there is evidence brewer demand is slowing, which will challenge long term growth.

Facing stiffer competition from the likes of Starbucks and questions over soda, GMCR is rich at 32x earnings.

Shares of Keurig Green Mountain (NASDAQ:GMCR) have been absolutely fantastic performers in 2014 as they are up 56%. Much of the rally has been due to Coca-Cola's (NYSE:KO) strategic partnership with the company to offer soda on its platform. Over the past five years, Green Mountain is up an even more impressive 403%. With its innovative k-cups that made home brewing quality coffee so much easier, GMCR has made its investors a lot of money. However at some point, shares fully reflect the underlying positives in the company, and I think GMCR is at this point. After reporting mixed quarterly results, I think now is time to sell GMCR as its valuation is excessive.

In its fiscal third quarter, GMCR earned $0.99 on sales of $1.02 billion. While earnings beat by $0.11, revenue was $30 million below estimates, meaning year over year growth slowed to 5.5% (all financial and operating data available here). EPS was up 21% compared to a year ago. The faster earnings growth was driven by a product mix more heavily focused towards higher margin portion packs versus brewers. The company also generated free cash flow of $127 million, which was 132% of GAAP net income. For the first nine months of the fiscal year, free cash flow was a positive $602 million. A $37 million year to date decline in inventory and $58 million increase in accounts payable have helped to increase free cash flow but won't be recurring cash flow.

Within the quarter, there were several points of concern. GMCR's portion pack volume increased by 15%, which is really solid growth. Unfortunately, portion pack revenue only increased by 10%. While Green Mountain sold more of its k-cups, they were selling for a lower price, which is a sign of increasing competition in the home coffee space as companies like Starbucks (NASDAQ:SBUX) are offering k-cups of their own. The loss of exclusivity on the platform continues to put pressure on pricing and will likely pressure margins in fiscal 2015.

More concerning, brewer and accessory revenue fell by 4% year over year. Green Mountain was able to increase brewer sales volume by 13%, but it only did so by cutting prices 21%. Management said the pricing cut was driven by the goal of cutting inventory ahead of a new brewer launch. Still, it was concerning to see prices fall more than volume grew. One would like to see volumes increase by at least as much prices are cut, which suggests underlying demand is strong. This relatively small volume increase makes me wonder if the next model will be as successful as hoped. Expanding the brewer base is critical as brewer sales lead to portion pack sales similar to how printers lead ink sales. Declining interest in the brewer bodes poorly for GMCR's longer term growth.

For all of fiscal 2014, GMCR expect earnings of $3.71-$3.78, which is in-line with expectations. There are two major questions for investors. First, the relative volume weakness in product and brewers suggest competition from Starbucks may be eating at market share and could challenge growth prospects. Additionally, we are still waiting for the company's cold drink brewer, which was the reason for the Coca-Cola partnership. Soda sales remain weak, and it is still unclear if this business will be able to generate meaningful revenue and earnings given stiff competition from SodaStream (NASDAQ:SODA). At 32x earnings, GMCR is priced for perfection, and any growth slowdown could send shares back below $100. At this valuation, I recommend selling GMCR.

Disclosure: The author is long SBUX. 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.