For better or worse, Green Mountain Coffee Roasters (Nasdaq:GMCR) is never a boring stock to watch. Caught in a tug-of-war between bulls and bears (the stock is up more than 100% over the past year, but over one third of the float is shorted), earnings reports always get more than their fair share of attention. This time around, the company made some respectable progress on margins, but investors may be getting a little too excited about the long-term implications of a new Starbucks (Nasdaq:SBUX) deal and a little too casual about unimpressive revenue growth trends.
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Progress In Fiscal Q2, But Perhaps Not Enough Of It
How Green Mountain did this quarter probably depends a lot on your bull/bear inclination on the stock. Revenue growth of 13.5% basically met expectations, but top line growth expectations have been coming down. Sales of the single-serve packs (the K-cups) increased 21% this quarter, offsetting declines in brewer revenue and royalty revenue. Brewer revenue declined 10% on a 9% decline in shipment volume.
Margins have been a major talking point on GMCR for some time now, and new CEO Brian Kelly appears to be having some impact here. Gross margin improved by almost six points, though about half of that came from lower green coffee costs. Operating income was up 41% as reported, with the company losing about two points of that gross margin benefit (operating margin improved four points) due to a 50% increase in G&A expense.
SEE: Understanding The Income Statement
A New Starbucks Deal – Relief Or A Real Opportunity?
I have little doubt that the real post-earnings excitement for Green Mountain is coming as a result of the announcement of a five-year extension (and expansion) of the company's agreement with Starbucks. I have to wonder, though, if investors are getting too excited about this deal.
Details were pretty sparse, but the companies agreed to a five-year extension that supersedes the old deal. What's more, the new deal will roughly triple the number of Starbucks-branded items available for Green Mountain's Keurig system – including Seattle's Best and Torrefazione Italia coffees, Teavana teas, and Starbucks cocoa.
That's all well and good to a point. It certainly helps Green Mountain to have licensed, branded partners like Starbucks in hand to offset single-serve competition from private-label players like Treehouse Foods (NYSE:THS) and other entrants like Mondelez (Nasdaq:MDLZ). Moreover, it doesn't seem unreasonable to read this deal as a sign that Starbucks' Verismo hasn't taken the coffee world by storm.
But I think it's important to note that the financial terms of the deal weren't released or discussed. Just how much is Green Mountain ceding to Starbucks to keep them invested in this relationship? As Green Mountain is essentially a razor/razor blade business model (making the money off the single-serve cups, not the brewers), that's no trivial concern. In a worst case scenario, I would fear that Starbucks is essentially just co-opting Green Mountain as another arm of its global distribution strategy.
Will Other Moves Improve The Long-Term Competitiveness?
These aren't the only moves underway at Green Mountain. The company is combining the specialty coffee (SCBU) business and Keurig, and will eventually launch a new brewing platform that will combine the Vue and K-Cup technologies. Time will tell how much this later development really helps – Vue didn't seem to be gaining much traction and Nestle (OTC:NSRGY) has certainly stepped up the advertising support for its Nespresso business.
At the same time, the company seems to really be focusing on identifying the “loose change” in its cost of goods, sales and marketing, working capital, and capital spending. Time will tell just how durable these improvements are (and how much is left to extract), but it's the sort of blocking-and-tackling that the company has needed for some time.
SEE: 5 Must-Have Metrics For Value Investors
The Bottom Line
Personally, Green Mountain Coffee isn't my cup of tea as a stock. Not only do I think consumer stocks in general have gotten too hot for their own long-term good, but I do have worries about whether Green Mountain is built to last in this market, or whether they've simply underwritten a large installed base of brewing systems that other companies will exploit with their private-label K-cups. Along those lines, I think the market reaction to the Starbucks deal (absent financial details) speaks to a strong “hope trade”. Accordingly, I'll be looking at other stocks for potential additions to my portfolio.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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