William Blair analysts Jon Andersen, Ryan Sundby and Luke Christianson maintain an Outperform rating for Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) as they provide a highlight of the Consumer Analyst Group of New York Conference.
On Wednesday, February 19, Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR)’ chief executive officer, Brian Kelley; chief technology officer, Kevin Sullivan; senior vice president – beverage research and development, Tom Novak; and chief financial officer, Fran Rathke presented at the 2014 Consumer Analyst Group of New York (CAGNY) Conference. Broadly, Green Mountain defines itself as a personal beverage system company, one that is intent on placing a Keurig brewer on every countertop and offering a beverage for every occasion. More tangibly, the company will seek to enhance its value proposition and extend its addressable market via the introduction of two major new beverage platforms—Keurig 2.0 and KeurigCold—over the next 18 months. If successful, this strategy should help drive greater household penetration, portion-pack consumption and, in turn, sustainable profitable growth. While the consumer value proposition of these systems is relatively well understood, they also create powerful incentives—through their ability to improve category growth rates and increase the profit pool across the value chain—which in turn should help coalesce support from suppliers, partners, and retailers. We maintain our Outperform rating.
Key Highlights from Consumer Analyst Group of New York Conference
Management believes its ownership of the two system components—appliance and portion pack—is an important ingredient in the company’s success and forms the basis of a unique competitive advantage. In hot beverages, it has enabled the company to engage in what it calls system engineering; in effect, to optimize the interplay between appliance and portion pack—resulting in a superior consumer value proposition, characterized by convenience, simplicity, quality/fresh taste, and consistency.
Innovation capabilities were highlighted
The company has two R&D facilities—one in Redmond for beverages and one in Boston for appliances—and more than 460 scientists and engineers. There are also 320 patents, and another 244 pending, globally. In addition, relationships with system partners create connections with numerous R&D groups at different companies, a degree of networking that brings a unique diversity of thoughts and external perspective.
Today, the company owns two $1 billion brands, Keurig and Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR). There are about 18 million U.S. households with Keurig brewers and, in aggregate, 50 brands and more than 250 varieties of beverages in the system. And management sees a network effect further enhancing both penetration and choice over time. That is, as more brewers are sold, more brands want to (and will) participate. This in turn enhances the appeal of the system and, ultimately, promotes further growth in the installed base.
While the consumer value proposition of these systems is relatively well understood, they also create powerful incentives—through their ability to improve category growth rates and increase the profit pool across the value chain—which in turn should help coalesce support from suppliers, partners, and retailers. For example, in 2013, end-demand (in dollars) for hot beverages in aggregate increased by 6%, while cold beverages declined by 1%. And within hot beverages, coffee and tea increased by 5% and 7%, respectively, while all other segments decreased by 1%. Moreover, the growth has been enabled by single-cup offerings—predominantly Keurig compatible—which grew by 44% in coffee and 38% in tea.
Improved the profitability of the categories
Keurig has not only helped drive end-demand, but also improved the profitability of the categories by creating a premium offering. End-demand (in dollars) for coffee and tea cumulatively rose by approximately 50% and 20%, respectively, from 2009 to 2013. Most notably, increases in price per equivalent serving—45% in coffee and 24% in tea—enabled this growth. And management believes it can continue to drive a similar dynamic in hot beverages and extend the impact to other (cold beverage) categories via the introduction of two major new beverage platforms—Keurig 2.0 and Keurig Cold— over the next 18 months.
As previously announced, Keurig 2.0 will be introduced in fall 2014; brew a single cup or pot/carafe of coffee; offer all Keurig brands and beverages currently in the system; employ a proprietary interactive technology to enhance quality and customization; and not brew unlicensed portion packs. Separately, we learned Keurig 2.0 will be offered at price points similar to the legacy brewer line and will be available at all retailers that currently carry Keurig brewers.
Management expects Keurig 2.0 to deliver several benefits, including increased household penetration, greater consumption per household, and volume and profit growth across the value chain. The new carafe functionality will remove the leading purchase inhibitor (other than price) for those consumers who have not yet purchased a Keurig. In addition, the ability to brew a pot of coffee will help Keurig capture a greater share of existing users’ requirements, 25% of which currently are not met by the Keurig system. And a growing installed base and higher portion pack usage rate should help profitably grow the coffee and tea categories to the benefit of value chain participants.
The Keurig Cold system will be introduced in fiscal 2015. A major point of differentiation from existing systems on the market could be simplicity/convenience—enabled by premeasured doses, the elimination of CO2 tanks, and flash chilling. More specific, portion packs (or pods) will contain two chambers—one with a premeasured dose of liquid syrup and one with a “pellet” (pre-form of carbonation) that is released when the drink-making process begins. This eliminates the need for CO2 tanks. The system will also flash chill the beverage so it is produced quickly; deliver precise syrup dosing for consistency; support a range of brands and beverage types; and be roughly the same size and offered at similar price points as the Keurig brewer. In addition, beverage selection should a differentiator, given that Coca-Coca’s (KO $37.10) portfolio of leading brands will be available for use in the system.
Green Mountain’s 2014 EPS growth
On a currency-neutral basis and excluding the dilutive impact from the The Coca-Cola Company (NYSE:KO) investment (and absent actions the company may take to offset dilution), underlying fiscal 2014 EPS growth is projected to be 14% to 17%. Giving effect to a foreign-currency headwind of $0.11 per share and potential dilution from the Coca-Cola investment, fiscal 2014 EPS are forecast in the range $3.55 to $3.65. Management noted that it has an existing share-repurchase authorization of $1.1 billion and expects to execute this program over the next year, funded in part by the $1.25 billion in proceeds received from the Coca-Cola investment.
Also for 2014, free cash flow is projected to be $200 million to $300 million, with capital expenditures of $400 million to $450 million ($200 million of which is to support new systems introductions and the SAP implementation), or about 9% of sales. Over the longer term, management expects capital expenditures to be in the range of 4% to 7% of sales.
For fiscal 2015, management guided to base-business earnings growth in the midteens. However, after potential dilution from the Coca-Cola investment and incremental growth investments for the Keurig Cold platform, the company expects EPS growth in the midsingle-digit range, or $3.69 to $3.90.
The balance sheet is strong, with net and gross cash of $90 million and $350 million, respectively. The capital-allocation strategy includes, in order of priority, reinvestment to drive revenue growth; return of cash to shareholders via share repurchase and in dividends; and—to a lesser extent—small tuck-in acquisitions for technologies or brands.]
Green Mountain’s valuation
Our fiscal 2014 and 2015 EPS estimates remain $3.65 and $3.90, respectively. We view the 2015 P/E multiple of 30 times as reasonable given Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR)’s leadership position in single-serve, pod-based segment of the hot beverage market in North America, a position it appears ready to extend with the coming introduction of Keurig 2.0. In addition, with Keurig Cold in development and Coca-Cola as a long-term strategic partner, Green Mountain appears poised to accelerate the market development and consumer uptake for similar systems in the cold beverage industry. We believe this creates the potential for above-average earnings growth over time. We maintain our Outperform rating.