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Over-Caffeinated Growth Expectations at Green Mountain Coffee

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Last week, Starbucks (NASDAQ: SBUX) finally announced its "Verismo" single-serve brewer, just after Green Mountain Coffee Roasters' (NASDAQ: GMCR) key patents for its Keurig single-cup systems expired. But the Verismo does more than brew coffee: It makes lattes and other espresso-based drinks as well. And to put the icing on the cake, it's available at competitive prices.

Green Mountain Coffee investors didn't respond very well to the news. They knew the obvious: When it comes to coffee, Starbucks is a serious threat. Why, exactly?

1. Starbucks has scale and established global distribution
By the end of 2011, Starbucks had more than 17,000 stores in more than 55 countries. Starbucks makes up 29% of the U.S. coffee market. In fact, one out of every 100 cups of coffee sold across the globe come from Starbucks. The threat of Starbucks to Green Mountain Coffee becomes even more apparent when you compare their balance sheets: Green Mountain Coffee has $130 million in cash and cash equivalents, while Starbucks boasts a cash hoard of more than $2 billion.

2. The Starbucks brand commands a premium price
In fact, gross profit margins exceeded 56% in 2011. Long story short, the Starbucks brand is a powerful one. When it comes to coffee and Starbucks, consumers open up their wallets.

You can bet that Starbucks has both the financial power and the brand power to put Green Mountain Coffee's Keurig brewing system to the test.

Unrealistic growth expectations
At 12 times earnings, I'm surprised to see growth priced into Green Mountain Coffee at all. Yes, it was only one year ago that Green Mountain Coffee traded at $100 a share, but just because the stock has plummeted 75% does not mean that it is undervalued. With patents expiring and competition from the world's most recognized coffee brand, I see no reason to expect any growth from Green Mountain at all.

Green Mountain Coffee at 12 times earnings is a classic example of unsolicited exuberance. Perhaps investors feel they are being conservative, since they are estimating a huge decline in growth rates. But there is no reason to anchor to past growth rates. With Starbucks in the picture, Green Mountain Coffee's primary product is seriously threatened. And unfortunately for Green Mountain Coffee, 89% of its revenue comes from their Keurig brewing system. In fact, a conservative estimate of Green Mountain Coffee 2012 holiday sales and 2013 sales would likely forecast a comparative decline.

If you want to pay for growth or predict growth at all, ensure the company has an economic moat -- a durable competitive advantage. As far as I'm concerned, with Starbucks in the market, Green Mountain Coffee has no moat.

Finally, why pay such a premium for growth when there are companies like Apple (NASDAQ: AAPL), and Google (NASDAQ: GOOG) that have established economic moats, strong growth, and relatively conservative P/Es (considering their historical three-year growth rates and future expectations)? If you're going to pay for growth, you'd better be certain the growth will occur!

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>3-Year Avg. Earnings Growth</strong></td> <td><strong>P/E</strong></td> </tr> <tr> <td> <p>Apple</p> </td> <td>61.81%</td> <td>16</td> </tr> <tr> <td>Google</td> <td>32.07%</td> <td>22</td> </tr> <tr> <td>Starbucks</td> <td>58.05%</td> <td>28.5</td> </tr> <tr> <td>Green Mountain Coffee</td> <td>107.6%</td> <td>11.4</td> </tr> </tbody> </table>

Green Mountain Coffee might initially stand out in the above chart, with more than 100% average growth per year for the last 3 years and a P/E of only 11.4. But now that Starbucks has entered the picture, Green Mountain's growth story has taken a nosedive. Plus, a closer look at Green Mountain Coffee's growth rates will reveal that recent growth has slowed dramatically. Even management has expectations of only 15%-20% growth in sales for the next 12 months -- and the company announced this before Starbucks revealed its Keurig killer. 

The bottom line
How can you predict growth in sales without some sort of durable competitive advantage? Unfortunately, Green Mountain Coffee lost its durable competitive advantage when its key patents expired. Starbucks is a formidable threat, and it's difficult to estimate exactly how significantly Green Mountain Coffee will be affected by Starbucks' entry into the single-serve brewing market. Think twice before you bet your hard-earned money on growth, and ensure that your growth expectations are realistic.

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DanielSparks owns shares of Apple. The Motley Fool owns shares of Apple, Google, and 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 Apple, Google, 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.

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