Green Mountain Earnings: Margins Likely To Widen But Watch Out For Volumes

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Green Mountain Coffee Roasters ( GMCR ) is scheduled to announce its Q1 earnings on February 5. For the ongoing fiscal (i.e. Oct'13-Sept'14), the company expects an earnings of $3.75-3.85 per share on high single digits revenue growth. Shares of the company have jumped about 20% in the last three months in anticipation of the upcoming Keurig 2.0. With the new version of the brewers, Green Mountain aims to combine the features of the traditional Keurig brewers and the Vue brewers. Moreover, both K-Cups and Vue packs will be compatible with the new brewer.

Green Mountain recently released some details about the brewer. It will let users brew three cups in a single go. The company decided to add this feature after a number of users complained that they were interested in a pot of coffee, rather than a cup of coffee. Green Mountain estimates that one-fourth of its users use a different coffee machine when brewing a pot of coffee. With the Keurig 2.0, the company could nudge some of these users to ditch other brewers and use Keurig instead.

We have a $69 price estimate for Green Mountain Coffee Roasters , which is about 10% lower than the current market price.

In the upcoming quarter, here are some of the trends to watch out for:

K-Cup Volumes Critical To Overall Profitability

K-Cup volumes will once again be under the spotlight. Green Mountain's coffee pod volumes were expected to be adversely affected after two of Green Mountain's patents expired in September 2012. However, the company has so far been able to defy its skeptics, by reporting strong volume growth of its K-Cups, often exceeding 20% on a year-over-year basis. During the previous fiscal, Green Mountain's K-Cup volume jumped 26%.

On the other hand, the volume gains have also eroded some of the pricing.With increased competition from private labels, there was always going to be pressure on pricing, but overall Green Mountain has played the pricing vs volumes game well. Since the K-Cups account for a disproportionate amount of the company's profits, any drag on the their volumes can adversely affect the company's profits.

Brewer Volumes

Brewer volumes have seen some weakness in recent quarters, especially in the at-home category. After dominating the at-home market, Green Mountain sees a potential to boost sales in the away-from-home category. For example, during the fourth quarter of fiscal 2013, the company sold 73,000 brewer units to Hilton Garden Inn, which buoyed the overall brewer volumes. Thus, depending on how many brewers the company is able to sell in the away-from-home category this quarter, the brewer volumes could exceed or miss the estimates. We expect a volume growth in the region of 6-8% in 2014.

Gross Margin Consolidation

In the first quarter of the previous fiscal, Green Mountain posted gross margins of 31.3%. Margins in the first quarter tend to be lower than the full-year margins, primarily because of the product mix. Brewer sales tend to swell with the onset of winters. Since brewers have significantly lower margins than coffee pods, a greater proportion of brewer revenues within the overall revenue pushes down the margins. Green Mountain usually sells brewers at prices close to cost price since it wants to boost the adoption rate. The company derives most of its profits through the sale of K-Cups.

Green Mountain should see a considerable improvement in its gross margins (on a year-over-year basis), primarily because of low coffee prices. In the recent quarters, Green Mountain has seen its margins widen significantly, often jumping more than 500 basis points, on a year-over-year basis. The magnitude of margin expansion in the upcoming earnings will depend on the effective raw material prices realized by the company. Coffee companies usually lock their coffee supply during times of low coffee prices.

Coffee prices remained subdued in 2013 as a result of a production glut in Brazil, the world's biggest producer of arabica beans. The prices have rebounded recently on the back of an anticipated drought in the country, but that will not have any impact on the upcoming earnings.

See our full analysis of GMCR here

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: GMCR , SBUX , DNKN



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