Green Mountain Coffee Roasters (NASDAQ:GMCR) and Starbucks (NASDAQ:SBUX) shares got a caffeinated jolt today after news broke that Starbucks blends would be sold in the popular K-Cup brewing system. The reaction was not justified.
Jeff Hansberry, president of Starbucks Global Consumer Products Group, bragged in a press release that the deal would enable the coffee retailer to “build Starbucks system wide sales of K-Cup into a $1 billion business over time.” Not surprisingly, he wasn’t more specific. The Starbucks K-Cups will go on sale starting in November. Starbucks has not ruled out selling its own singe-cup coffee maker, though that seems unlikely.
The deal underscores how much Green Mountain and Starbucks, which announced a partnership in March, need one another. If Hansberry’s forecast is accurate, Starbucks will be responsible for about 23% of the K-cup maker’s estimated $4.35 billion in 2012 revenue. For Starbucks, Green Mountain would generate about 8% of the coffee retailer’s 2012-forecast revenue of $12.81 billion.
The timing of this deal is lousy. This year, prices of Arabica beans have soared 57% in New York while robusta surged 44%, according to Bloomberg News. This has caused Green Mountain and Starbucks to raise prices at a time when consumer sentiment is weak. Starbucks also must worry about cannibalizing sales at its existing 17,018 stores, where people pay top dollar for the Starbucks “experience.” Many coffee lovers consider anything not created by a well-trained barista to be an inferior brew. It also will cut into sales of Starbucks’ popular VIA instant coffee.
Moreover, Starbucks is late to the K-Cup craze. Dunkin’ Brands (NASDAQ:DNKN) announced earlier this month that select U.S. Dunkin’ Donuts locations would offer the company’s coffee in K-Cups. McDonald’s (NYSE:MCD) likely will offer K-Cups at some point. In 2005, Green Mountain began supplying McDonald’s with Newman’s Own Organics coffee, which GMCR roasted. The fast-food chain honored Green Mountain last year with its Global Best of Sustainable Supply award.
Starbucks’ success in this market is far from a given. Cash-strapped consumers also have a plethora of other high-quality, low-price coffee options available to them. The battle for coffee dominance also will be waged in the breakrooms of corporate America, where many workers are able to enjoy a jolt of java for free. Look for Green Mountain to offer Starbucks at a discount when sales begin.
The uncertainties surrounding both stocks are not reflected in their prices.
Shares of Seattle-based Starbucks are up about 20% this year. Wall Street remains bullish on the coffee retailer. The average analyst price target on the stock is $43, ahead of the $38.29 where it recently traded. It trades at a premium multiple of above 25, ahead of the S&P 500’s average multiple of 16.1, which doesn’t appear to be justified given that revenue in the current quarter is due to increase 3.9%, 8.5% in the current fiscal year and 10.3% in the next fiscal year.
The situation is worse at Green Mountain. It trades at a price-to-earnings ratio of 68.26 on current-year estimates, more than four times the average multiple of the S&P 500, which is 16.1. Wall Street analysts expect the Waterbury, Vt., company’s revenue to more than double in the current quarter to $761.36 million. The problem is costs are soaring, too. Selling and operating expenses jumped to $95.5 million in the 13 weeks ended June 25 versus $45.69 million a year earlier. During that same time, general and administrative expenses rose to $49.3 million, up from $25.3 million.
The Green Mountain-Starbucks alliance is a marriage of convenience. Whether the two firms will live happily ever after remains to be seen.
Jonathan Berr does not own shares of the firms listed. Follow him on Twitter at @Jobber.