Patent expiration often heralds slower growth for innovative
Such has been the case withKeurig Green Mountain (
), which sells single-cup coffee brewers along with single
portion K-Cups of their own and licensed brands of coffee.
The expiration of key patents in September 2012 let unlicensed
rivals win share in the lucrative K-Cup market.
Keurig, which boosted sales at a compound annual clip of
roughly 55% from 2009 to 2013, was forced to make do with more
pedestrian low double-digit growth levels. Some bearish observers
wondered if the market for single cup-coffee was as robust as
But Keurig, on the verge of introducing two major products,
thinks it has the solution to slowing growth. And Wall Street
seems convinced. Keurig stock, which ended 2013 priced just under
$75, recently fetched over $120.
Keurig's Composite Rating -- 98 of a possible 99 --puts it
first among the eight firms in IBD's Wholesale-Food industry
group. With a market value of just over $20 billion, it ranks
second in size only toSysco (
) among those eight.
Still, the company has had to weather declining revenue growth
in the past two years. Sales growth, which as recently as the
quarter ended Sept. 30, 2012, stood at 33%, was just 10% in the
quarter ended March 31. Even with slower revenue growth, Keurig
has been able to expand earnings per share nicely: EPS rose 16%
Later this year, Keurig will unveil a new system that brews
whole carafes of coffee as well as its familiar one-cup servings.
Perhaps more important, the Keurig 2.0 brewers threaten to lock
out unlicensed purveyors of K-Cup compatibles.
Next year Keurig will carve out new product territory with its
Keurig Cold system for at-home carbonation of soft drinks.
Coca-Cola Co. (
) has invested in the at-home carbonation concept by purchasing
16% of Keurig shares. Coke's share purchases seem to validate
Keurig's carbonation product plan. They've also fueled
speculation of a buyout.
Akshay Jagdale, analyst with KeyBanc Capital Markets, makes
the bullish case. "We think the company can triple to quadruple
its earnings in a three to five year period. It has the potential
to do that," he said in a phone interview.
He believes Keurig's core brewing business is far from
saturation and that Keurig Cold will offer new capabilities
beyond those of existing home-carbonation platforms.
"Five years from now, they have the potential to earn $8.20
from the hot platform and $3.50 from the cold," he said. Jagdale
has a price target of $150. If Keurig's hot and cold businesses
flourish as he anticipates, the stock would be "a steal" at his
price target of $150.
Others have their doubts. Theo Brito, an analyst with BTIG, a
New York-based trader for hedge funds, mutual funds and other
institutional clients, begins by throwing cold carbonated water
on the notion of a Coke buyout, which he terms "very unlikely."
His fundamental skepticism is centered on Keurig's core brewing
Pods And Profit
Keurig brewers are in roughly 18 million U.S. households.
Suzanne DuLong, Keurig vice president of investor relations,
notes that there are 90 million coffee-drinking households in
America. "We think there's still ample opportunity with our Hot
systems," she said.
Brito questions whether all those 90 million households have
the income or inclination to purchase a Keurig brewer, which can
run from $80 to $189.
Brito claims that as Keurig has expanded sales, the average
number of cups brewed on its machines -- the attachment rate, in
industry lingo -- has declined.
"Over the last five years, there's been an annual decline of
around 10%," Brito told IBD. "I expect the decline to
That's important because Keurig derives the bulk of its profit
from K-Cups, not brewers. Declining K-Cup sales would definitely
pinch margins, he contends.
Still, Wall Street bulls have been winning the argument on
Keurig this year. And KeyBanc's Jagdale tackles the bearish
doubts head-on. He contends that Keurig has the potential to
vastly increase the household presence of its brewers.
In Europe, he notes, single-serve brewers are in 30%-35% of
households. Keurig currently has just 20% penetration.
And Jagdale foresees huge gains in single portion coffee as
the new Keurig 2.0 locks out unlicensed packet providers. In just
the last year and a half, unlicensed sellers have gone from zero
to roughly 14% of the K-Cup market, he notes.
"The Keurig 2.0 brewer will not allow any unlicensed cups to
work with it," he said.
Jagdale sees signs that the strategy is already working. He
notes that several retailers -- includingTarget (
) -- that had been unlicensed have recently entered into
licensing arrangements with Keurig. He suggests that retailers
prefer sharing coffee packet revenue with Keurig to being locked
out of the business entirely.
Jagdale does not venture to predict the likelihood of
Coca-Cola expanding its equity ownership in Keurig Green
Mountain. "It's hard to predict what will happen with buyouts,"
He does think the likelihood of buyout "will increase with the
success of Keurig Cold."
The Cool Factor
Keurig Cold systems will hit the market in 2015. Keurig
spokeswoman DuLong says that at $80 to $189, Keurig Cold units
will carry similar pricing to Keurig brewers.
Consumers have other choices for at home carbonation,
including products from market leaderSodaStream International (
Still, the market is in its infancy and Jagdale is impressed
with one expected Keurig Cold feature: "It will be the only
product that can produce a cold beverage."
The Keurig carbonators could begin to contribute as much as
$3.50 in EPS just three years after their 2015 introduction ,
Jagdale estimates. That's one reason he expects Keurig to get
back on the fast growth track.
"You're going to see an acceleration in top-line growth for
Keurig," he said.