Green Mountain Earnings: Patent Expiries And Competition Could Spoil The Party

| About: Keurig Green (GMCR)
This article is now exclusive for PRO subscribers.

Green Mountain Coffee Roasters (NASDAQ:GMCR), the leader in the single-cup brewer market, is scheduled to announce its Q1 results on Feb. 6. Anyone who has followed the stock closely over the years knows that its results have a habit of surprising investors. The last quarter results came in above expectations, after which the stock has surged more than 50%.

Here are some of the things to watch out for in the upcoming earnings release.

Brewer Sales

The company hardly makes any profits through the sale of its K-Cup brewers as it usually sells them near cost. However, strong brewer sales are more likely to correspond to higher K-Cup sales which, in turn, means more profits. While we believe that Keurig brewers are still going to remain at the top because of the high degree of compatibility they enjoy with third party and private-label brands, rising competition from Starbucks’ Verismo could slow growth.

Vue Sales

While revenues generated from sales of Vue brewers and V-Packs (the corresponding equivalent of K-Cups) constitute only a tiny proportion of overall sales, its importance shouldn't be overlooked because these brewers are priced much higher and are therefore more profitable.

Moreover, if the brewer sells briskly, it will attract the attention of third party companies who will look to introduce their own V-Packs. Any third-party company that wants to introduce its Vue packs will have to pay a royalty to Green Mountain. Thus, lower adoption rates would imply an opportunity lost to generate additional royalty revenues.

Vue sales (brewers and packs combined) halved to $9.6 million from $20 million in the third quarter.

Gross Margins

This metric is the most prone to rising competition from inexpensive private labels. Although customers might still be inclined to buy Keurig brewers, they don't necessarily have to buy Green Mountain K-Cups. While that was true earlier as well, at least Green Mountain profited from third party K-Cup sales (by means of royalties). However, things have become tougher from September onward when two of its patents expired, leaving the door open for private labels to introduce their own K-Cups without having any sort of obligation to pay royalty fees to Green Mountain.

In the previous quarter, margins were already down to 33.4% from 35.7%. This is likely to deteriorate further due to the sudden influx of inexpensive private labels in the market. Margins in the upcoming results will highlight the kind of pricing Green Mountain can sustain for its K-Cups now that cheaper alternatives have flooded the market.

In short, while the previous quarter earnings were strong, things could be different this time because of the following reasons:

  1. Green Mountain's patents expired in the second week of September, meaning that they hardly affected the last quarter results. The company's previous results were for the quarter ended Sept. 29, 2012. It will be much tougher this time around. Cheaper private labels could erode K-Cup pricing and eat up its margins. At the same time, they could also impact K-Cup sales as customers opt for more inexpensive items.
  2. Rising competition in the single-cup brewer market. Starbucks' Verismo, launched in September, sold 150,000 units in the quarter ended Dec. 30. Its sales could pick up further in the coming quarters helped by an expanding distribution network and a general acceptance of the product aided by word of mouth.

We have a price of $29.40 for Green Mountain Coffee Roasters, which is about 20% below the current market price.

Disclosure: No positions.