K-Cup's D-Day on Sept. 16 = Green Mountain Under Attack
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Note: This article had an incorrect piece of information, which is now corrected.
I hope your experience with Green Mountain Coffee Roasters (NASDAQ: GMCR) this summer just involved using a Keurig to brew coffee or whip out a cold beverage, rather than investing in its stock. While the dog days of summer have ended, GMCR's dog days bark on with new ferocity -- the stock plunged 9.6% Thursday on 70% higher than average trading volume. And it's down over 3% as I type this on Friday.
Starbucks (NASDAQ: SBUX) announced on Thursday that it has begun selling its single-serve coffee maker, the Verismo. So GMCR's investors are on edge about how deep-pocketed Starbucks entry into the single-serve space will affect GMCR's current stranglehold on the market. GMCR has a 70% share of the U.S. single-serve market, which includes brewing machines and cups containing the coffee pods.
Starbucks investors drank to the news, driving the stock up over 2% on Thursday.
(For you word folks -- "Verismo" is derived from the Italian vero, meaning "true." It's widely used to describe the realistic Italian opera style of the late 1800s/early 1900s. Great name choice -- espresso has Italian roots and the word sounds powerful.)
Awake & Smelling the Coffee
It seems some GMCR's investors awoke on Thursday with a caffeinated jolt after sleeping through six months of news. Starbucks announced in March that it would enter the single-serve space this fall. So the fact that it did shouldn't have come as a surprise.
Likely a factor was that much of the early buzz had Starbucks' machine limited to espresso and latte capabilities, lacking regular coffee brew capabilities, and this was inaccurate.
Will Verismo K-O Keurig?
The Verismo is available now on Starbucks' website, and will be available at select retailers in the first week of October and Starbucks cafes by mid-October, according to the Wall Street Journal.
Here's a basic comparison:
Round 1: Price
- Verismo -- $199 basic model, $399 for the larger model with more features
- Keurig -- $99 to $189
Round 2: Beverage Capabilities
- Verismo -- Can make brewed coffee, espresso and a latte with fresh milk
- Keurig -- Keurig Vue can produce cafe beverages
Round 3: Brands of Coffee Available
- Verismo -- Just Starbucks at this point
- Keurig -- Wide range, including Starbucks
The winner of the above rounds is debatable. However, what's not debatable, in my opinion, is GMCR's death unless the one-hit wonder can pull other hit products out of the cup.
Death by a Thousand Cups
GMCR is likely doomed regardless of how much Verismo eats into Keurig sales. The fact that mighty Starbucks has brought the Verismo to market will likely just hasten GMCR's death.
While Starbucks entry into this market is a huge concern, it's not the primary issue. The primary issue is the expiration of GMCR's two key K-Cup patents on Sept. 16, as the company derives most -- about 75% -- of its revenue from K-Cups. Like the Verisimo's entry, this news has also long been out, so should not have come as a surprise.
GMCR employs a razor-and-blades strategy, selling the less-frequently purchased "razor" -- brewer -- at little profit, in order to sell the frequently-purchased "blades" -- K-Cups -- at a tidy profit. This strategy has worked wonderfully, but it's not going to work going forward because the market for K-Cups is now wide open. And what happens when competitors enter a once-protected market? Prices drop.
There are two things that will surely happen and two that could happen:
1. GMCR will lose sales of K-Cups to those that produce K-Cups for less money. The only questions here are how much and how fast? Sure, some will continue to buy GMCR's K-Cups as they currently come in the widest variety and are the sole source of certain favored brands.
2. GMCR will lose sales of its Keurig to competitors' products. Those on the market for a first single-serve machine now have more options. And some of those who currently have Keurigs will replace with competitors' models when replacement time rolls around. So, they'll be buying whatever cups work with their machines.
3. Starbucks could decide to conquer this market. Starbucks has $2.5 billion in cash and had a positive cash flow of $804 million over the trailing twelve months, while GMCR has $139 million in cash and had a negative cash flow of $95 million. GMCR has contracts with various coffee brands, including Starbucks, to produce K-Cups. I don't know if some or all are exclusive, but would assume so. However, once any exclusivity contracts run out, Starbucks could easily partner with these other coffee brands to produce their K-Cups. Yes, at first this could look like cannibalization of the Starbucks brand, but it would not change the current Keurig K-Cup dynamics. People who prefer Starbucks already buy it to use in their Keurigs, while those who prefer other brands already buy them. The only difference here is that Starbucks would now get a cut of the profits of the other brands used in Keurigs.
4. Starbucks could also eventually allow other brands to be used in its Verisimo. This scenario would cannibalize the Starbucks brand, so it might be less likely to happen than the above. However, a company must be willing to cannibalize its own products -- or someone else will.
Single-Serve Coffee Market Cup Runneth Over
This is an $8 billion global market, which Starbucks CEO Howard Schultz has been quoted as saying tripled in size last year. This figure refers to the single-serve coffee market, so the broader single-serve beverage market is even larger.
GMCR has a roughly 70% share of the U.S. market. In an interview Thursday on CNBC, Schultz said that Starbucks already controls about a quarter of the K-Cup market. This is impressive, given Starbucks only entered the market less than a year ago when it inked a deal with GMCR to provide Starbucks branded K-Cups for use in Keurigs.
To give some perspective to the market size figure, GMCR's 2011 revenues were $2.65 billion. Earlier this year, the company expected revenues to be about $3.8 billion in 2012, representing a 43% annual growth rate. The company recently said it expects growth to slow to 15-20% next year. I'd not be surprised if growth slowed more than expected.
There are various single-serve brewers on the market.
Kraft Foods (NASDAQ: KRFT) has the Tassimo, which costs between $100 and $170. Starbucks had previously provided coffee discs for Tassimo, but has ended that agreement.
Nestle has its Nespresso, priced from $199 to $699. However, these only make espresso and espresso-based beverages such as lattes and cappuccinos. The bulk of sales are in Europe.
Espresso is considerably more popular outside the U.S., which will help Starbucks' Verisimo in the international market. GMCR has partnered with Italian coffee roaster Luigi Lavazza to bring an espresso machine to market; reportedly, it will be available in select markets by year end. I don't know whether this will just be an espresso maker or will also have regular coffee brew capabilities. It better have both -- most people will not want two countertop gadgets when one will do.
Wal-Mart (NYSE: WMT) is entering the market as the exclusive seller of the Esio single-serve hot and cold drink maker. The Esio will launch in U.S. stores in October retailing for under $200, per a Sept. 9 press release. There will initially be 30 branded drink choices available, including juices, lemonade, sports drinks and vitamin fitness waters, as well as iced or hot coffees and teas.
Foolish Bottom Line
I think GMCR is roasted, though it could take a while given the huge number of installed Keurigs. All barriers to entry are now down, and there are deep-pocketed competitors, namely Starbucks and Wal-Mart, further entering or newly entering the market. Starbucks, Wal-Mart, and Kraft can all afford slim profit margins on their single-serve brewers and cups/pods. Any additional profit they make from here on out is whipped cream on their earnings. GMCR can’t survive this scenario as its entire business is the single-serve market.
GMCR will never be the high-flying stock it once was unless it comes out with another hit product ASAP -- not any ole hit, but another innovative mega-hit. The chances of this are slim to nil.
Investor takeaways --
- Invest in companies with sustainable competitive advantages and sell the stock in companies when those sustainable advantages disappear.
- Investing in companies that have just one product line is very risky even if the product line is very profitable and appears non-stoppable. Cases in point -- Kodak and Research in Motion.
BAMcKenna has no positions in the stocks mentioned above. The Motley Fool owns shares of Starbucks and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters, short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters, and short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Green Mountain Coffee Roasters and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.