What a difference a year makes. Green Mountain Coffee Roasters (GMCR) is experiencing a dramatic reversal of fortune. In an apparent change of heart, Starbucks (SBUX) announced its decision to provide its own single-serve coffee brewer. A mere twelve months ago, Starbucks agreed to distribute its coffee through Green Mountain's Keurig brewer, and Green Mountain's stock soared from $35 to $100. I believe this signals the commencement of a death-spiral at Green Mountain Coffee Roasters.
Sales Growth Fueled Stock Returns
Shares of the maker of the convenient Keurig coffee machines soared from $5 in 2009 to $100 in 2011, splitting twice along the way. Over this period, sales increased from $800 Million to $2.6 Billion, a healthy 300% growth in sales. Unlike competitors of online streamer Netflix (NFLX), Green Mountain's brick-and-mortar competitors, Starbucks and Dunkin Donuts, initially decided to join forces and leverage the Keurig platform to distribute its coffee. Investors rewarded Green Mountain's shares with a triple-espresso rally.
Unprofitable Razorblade Model
But beneath the top-line growth lay a troubling, but quiet, fact- Green Mountain had negative free cash flow from 2009 to 2011. In other words, Green Mountain spent more cash than it received each period. As an investor, we expect a business with an economic moat to have positive free cash flow. Indeed, Green Mountain employs the classic razor-blade business model; similar to Gillette, it sells the "razor" (Keurig machine) at cost and then its proprietary "razor blade" (K-cup) replacements at a premium. HP had big success with their printers (razor) and the replacement ink cartridges (razor-blade). Similarly, Amazon has big success with its Kindle (razor) and its e-books (razor-blade). Curiously, Green Mountain never seemed to have much success with this model, as its free cash was always negative.
With dramatic sales growth and positive news stream from distribution deals from Starbucks and Dunkin' Donuts and others, the market shrugged off this telling investment red flag. But now, with decelerating sales, the market is beginning to understand that while Green Mountain the product is great, Green Mountain the company is not nearly as stellar. Green Mountain's rally was a bit of bubble, as large investments in assets fueled the large gains in sales. With a deceleration in sales growth, weak spots in the model became more apparent. I see growth decelerating further, now that the Starbucks, the 800-pound gorilla, is entering the space.
Green Mountain Coffee Roasters is a good short at this point, as the Starbucks news represents an additional overhang on the shares. As sales growth declines, investors are likely to focus more on Green Mountain's lack of the lack of profitability and sustainable competitive advantage.