The Wall Street Journal published an interview with Green Mountain Coffee Roasters CEO Larry Blanford on Sept. 18, 2012. This followed a tumultuous period for the company, which has seen its stock fall 75% from its 52-week highs and forced margin calls for some of its executives. Below are some excerpts from the interview and our responses to Blanford's comments.
On accounting policies and David Einhorn's critique: "Anything like that is immediately turned over to our audit committee and they independently evaluate and review them using outside auditors and legal counsel. There have been no issues found whatsoever."
Einhorn conducted thorough due diligence highlighting multiple issues with GMCR, including accounting red flags, expired K-Cups on shelf, and inventory issues. Perhaps Einhorn is factually incorrect, despite his track record of deep research and the breadth of evidence in this case. But if he's right, all of these issues have been present since Blanford became CEO in 2007, and the CEO has every incentive to keep the story going.
On the allure of K-Cups: "Part of the attractiveness of the system is its broad choice. A consumer may want a strong cup of coffee in the morning to help them wake up, then in the middle of the day they may want a medium roast, after dinner they might want a flavored coffee instead of dessert and then in the evening, a decaf."
It seems dubious that the discerning coffee aficionado is much of their market. The primary draw of the K-Cup, which costs multiples more than traditional bean brewing, is convenience.
On Starbucks' new Verismo machine: "I think [its] single-serve system is first and foremost an espresso single-serve system."
The Verismo machine is being marketed as an "espresso and coffee" machine and has both capabilities. It will also retail for $199. GMCR has launched a new Vue machine. Blanford had this to say about it:
Vue has been designed with more flexibility to accommodate a wider range of beverages beyond coffee, including cold beverages. We now have hot tea, hot cocoa, fruit-based beverages, hot apple cider, and lemonade.
Finally, on the critical September 2012 K-Cup patent expiration: "Patents are granted to inventors to give them a head start. They are not forever. We continue to file for patents, but that's not how we really built the business."
Keurig does deserve credit for the explosive growth in K-Cup use, and over time it has acquired a slew of premium coffee brands that will continue to command a premium to store brand K-Cups, just as private-label beans are cheaper than Starbucks and others. But competition is also exploding, with Kroger, Safeway, and Supervalu launching private-label K-Cups. As Einhorn noted, the Starbucks agreement is more likely to be akin to a lower-margin contract manufacturing deal. Unlike with Gillette razors, the pod is less technology and much more susceptible to being commoditized.
The patents are paramount. GMCR has enjoyed relatively high operating margins -- 15% in its most recent quarter -- due to its monopoly position in K-Cups, which has just ended. Despite the patent protection, returns on invested capital have never been that impressive. They were 34% in the 12 months ending June 2012. Return on assets was even weaker, at 16%, due mostly to all the goodwill GMCR is carrying from high-priced acquisitions of coffee brands. We think profitability has peaked and will see pressure due to what will soon be rampant K-Cup competition. With GMCR shares up nearly 70% from their 52-week low, a short position may be timely.
Disclosure: I am short GMCR.