The Foolish Case for Green Mountain Coffee Roasters

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

Green Mountain Coffee Roasters (NASDAQ: GMCR) is among the largest specialty coffee producers in the U.S. Founded in 1981, the Waterbury, Vermont-headquartered GMCR produces and sells more than 200 varieties of coffee, tea, and other beverages. With $2.7 billion in revenue, it is the fourth largest company in the state of Vermont. What made this company a huge success was the invention of K-Cup portion packs. The company's single-cup brewing systems are incredibly popular among retailers and households alike. While the stock used to be a Wall Street darling, it lost its mojo since David Einhorn's bearish comments at the value investment conference last year.

Business Basics

Green Mountain has an interesting business model where the company has a somewhat monopolistic position among its customers. First, the company produces and sells Keurig Brewers to households. While these brewers cannot be considered as cheap, they are known as premium coffee brewers. Those brewers form the backbone of Green Mountain's business model.

Once, the customer is acquainted with brewers, they keep on buying K-Cups from Green Mountain. Those K-Cups are sold at very high premium prices. A Green Mountain brand breakfast blend sells for about $16 per pack. This pack offers a total serving size of 18. Thus, the price paid for the coffee is about 70 cents per cup. For comparison, a pound of Sumatra blend premium coffee from Starbucks (NASDAQ: SBUX) cost about $15 and offers 45 servings per package. In that case, the price paid for the coffee is about 33 cents per cup. From these calculations, it is obvious that Green Mountain knows how to monetize its monopolistic position once it sells the brewer.

Starbuck's Bold Move into Green Mountain's Territory

Realizing the potential in single-cup brewer market, Starbuck's recently made a bold move into Green Mountain's territory. The company started selling its first ever single-cup coffee machine from its website. The machine named, Verisimo, will soon be available on specialty stores such as such as Williams-Sonoma and Sur La Table. The Wall Street journal also claims that Nestle is about to enter this market with its own design. I think this is not bad news for Green Mountain. The market for single-cup coffee machines is pretty large and it is expanding. Starbuck's' and Nestle's move into the single-cup specialty coffee market makes Green Mountain a potential takeover candidate.

Recent Performance

After losing more than half its market cap, Green Mountain has fallen deep into oversold territory. In 2011, it was trading for as high as $110. Surely, its valuation was extreme at that time, but currently the stock looks like a dirt-cheap deal. GMCR is trading at P/E ratio of 10.9. Its current ratio is 2.4. Thus, the company has substantially more current assets than current liabilities.

Source: Finviz.com

After losing more than 80% of its market capitalization, Green Mountain looks like a good deal. It supports a single digit forward P/E of 9.3, which is the lowest in the industry. Steve Mandel's Lone Pine Capital is also bullish on the stock. The hedge fund guru has invested about $300 million in the company.

Valuation

I also estimated the fair value of Green Mountain based on my FED+ Valuation Technique. Morningstar suggested a five-year growth rate estimate of 20%. However, I decided to use a conservative growth estimate of 10% for the next 5 years. I also used a discount rate of 11% for discounting the future earnings. After making the necessary calculations, I came up with a fair value range of $34 to $48.

I also used a backward calculation to estimate how the market values Green Mountain at the moment. My calculations suggest that the stock is priced for zero growth at the current valuation.

Foolish Summary

The K-Cups are obviously expensive compared to the rest of the brands in the market. However, I do not think it makes much sense to compare K-cups with the rest of the brands.

People are willing to pay premium prices for the coffee they drink. Coffee itself is an addictive product where the addiction also applies to the coffee brand. Green Mountain has found itself a nice niche market and its users are happy with the price they pay.

Surely, there will be others entering this market, but Green Mountain will still have this brand loyalty. I think Einhorn's bearish thesis was quite right when the stock was trading at above $100. However, at the current valuation, the stock offers a deep value. It is priced for zero growth, but I expect the company to experience double-digit growth rates.

Interested in Additional Analysis?

With Green Mountain as cheap as it's ever been, many investors are wondering whether this is the end of the former market darling, or the perfect entry point for an enormous rebound. You can find a recommendation for how to approach investing in the company in The Motley Fool’s new premium research report. In it you'll find everything you need to know about Green Mountain, including whether it's a buy at today's prices. Click here for instant access.


ecofinstat 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.

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