2 Big Lies About Green Mountain

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

One thing that all investors need to be cautious about is believing what they hear just because they hear it a lot. There are two huge lies that are constantly being told about Green Mountain Coffee Roasters (NASDAQ: GMCR) that are not supported by facts, but they are being told over and over again. Let me help everyone out and bring some truth to the coffee table.

What's Been Happening Recently?

In a recent article by Rick Munarriz on Fool.com, he outlined the fact that Green Mountain is now offering mail-in rebates of both its Keurig and VUE brewers to try and combat the new Verismo machine by Starbucks (NASDAQ: SBUX). Since Verismo is priced at $199, Green Mountain is betting that $160 for its VUE brewer will entice customers to upgrade or buy a new brewer if they don't have one. The company is offering a similar rebate of $35 off its Platinum Keurig brewer, which sells directly for $179.95, making the price after the rebate $144.95.

These two deals are aimed at getting more people to buy the Green Mountain solution instead of looking at the Verismo. The more customers choose Green Mountain brewers, the better the company's results will be in the long-run. This leads us to the two biggest lies I've read about the company.

Green Mountain's Expired K-Cup Patents Will Lead To Much Lower K-Cup Portion Pricing

This statement is only partially correct. While there is no question that K-Cups will get cheaper because of the expiration of these patents, pricing won't change as much as one would think. First, it is important to establish that coffee drinkers don't buy based on price. If that were the case, Starbucks would have gone out of business a long time ago. The fact is coffee drinkers buy their coffee based on taste.

That being said, Green Mountain either owns or has “multi-year” license agreements that cover most of the popular K-Cups on the market today. I wrote about this in March  around the time Verismo was announced. Green Mountain directly owns the Green Mountain, Timothy's, Diedrich, Van Houtte, Tully's, Coffee People, Donut Shop, and Cafe Escapes brands.

In addition, most investors know that Green Mountain has agreements with both Starbucks and Dunkin' Brands (NASDAQ: DNKN) to co-market their K-Cup brands. Anyone who buys K-Cups from any of the above companies will probably pay a slightly lower price due to more competition coming to market. However, the price change won't be drastic because these brands have pricing power of their own. If you want proof, since these patents have expired and pricing can change instantly, you would expect some of these prices to have already dropped, right?

Prices have dropped, but not by any drastic amount. My own household has a Keurig brewer and we have been buying K-Cups for a while now. I am not one to waste money, so I routinely go online to find the best deal per K-Cup on the brands we enjoy. Last year when overall coffee prices were cheaper, it wasn't unusual to find K-Cups for $0.45 or $0.50 per K-Cup. I remember being able to buy a 50 count box for about $24 on Amazon.com and that was the best deal around.

However, coffee prices rose across the board, and all of a sudden it became nearly impossible to find K-Cups for less than $0.60 per unit. Those same 50 count boxes went to $32 per box. This wasn't because of Green Mountain, but instead it was an industry-wide price increase. Starbucks K-Cups have always been more expensive, with the standard package of 16 selling for about $12.99 or over $0.80 per unit. You would think if these patent expirations were going to lower prices, that the drop would be dramatic right? Here is just a sample of what I found yesterday between Amazon and eBay, which have traditionally had the best deals:

  • Coffee People – Jet Fuel flavor on Amazon $29.99 for 50 = $0.60 per unit
  • Coffee People – Jet Fuel flavor on eBay in quantities over 160 = $0.58 per unit
  • Starbucks - Cafe Verona flavor on Amazon $45 for 54 = $0.83 per unit
  • San Fancisco Bay coffee (non-licensed) on Amazon $17.49 for 36 = $0.49 per unit

You can see the cheapest option right now is the San Francisco Bay coffee pods at $0.49 per unit. I know these are non-licensed because they even say on the box that they are not licensed by Green Mountain or Keurig. The point is, prices have not changed that dramatically, and even new private label brands aren't likely to bring down prices much. The reason is simple: coffee drinkers choose on taste not on price. A person who has been drinking Starbucks K-Cups isn't likely to abandon their favorite flavor for a Kroger private label K-Cup. This would be akin to that same person driving past a Starbucks and deciding, “No I'll just get my coffee from the local convenience store because it's cheaper”.

Green Mountain Has To Win The Battle Of Perception

Green Mountain has already won this battle. The company wins this battle every time a person buys a Keurig machine. In its last “disappointing” quarter the company sold 51% more K-Cups on top of an 120% increase in the prior year. The company has sold at least 1 million new brewers each quarter for the last two years. The highest brewer sales have been in the first quarter of each fiscal year, with over 2 million sold in 2011, and over 4 million sold in 2012.

 I also think that as investors we have to remember that we operate in a slightly different world than people who don't think about stocks all the time. I know the Verismo is being sold, but does the average customer? If they aren't in Starbucks or “select retailers,” then the answer is probably no.

In addition, just because Green Mountain lost K-Cup patents does this change the perception of the average person about buying K-Cups? I live and breathe investments and stock information, but I suspect that many people are creatures of habit. If a customer likes the Jet Fuel flavor by Coffee People (owned by Green Mountain), they may notice that the K-Cups are a little cheaper, but will they try out a store brand instead? Customers have to be dissatisfied with a product to switch to something else. The point is, with millions of Keurig brewers already in people's homes, Green Mountain is winning the war of perception.

Conclusion

When it comes right down to it, Green Mountain's business hasn't really changed. The average consumer is likely to stick with what they know unless something significantly different comes about. For customers who spent $199 on a Keurig, a new offering is going to have to be very compelling to get them to change.

In the meantime, Green Mountain's stock sells for just under 11 times forward estimates. By contrast, Starbucks sells for almost 28 times estimates, and Dunkin' Brands sells for almost 23 times estimates. Green Mountain still projects a higher growth rate than either of its main competitors. The idea that Green Mountain is dead in the water because it's “only” expected to grow at 20% instead of 30% is foolish (small f).

We will find out when the company reports earnings what effect the patent expirations had. I suspect that the impact won't be significant enough to warrant the massive markdown in the stock. If you ignore the lies being told and look at the facts, Green Mountain is continuing to change the way people drink coffee, one K-Cup at a time.


MHenage owns shares of Green Mountain Coffee Roasters. 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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