We’re down to the final two weeks of trading in 2011, and Green Mountain Coffee Roasters (NASDAQ:GMCR) continues its fall from grace. On Aug. 31, I recommended investors sell this stock, which at the time was up 200% year-to-date. My rationale for selling boiled down to the simple fact that Green Mountain’s competition was heating up.
Since that time, Green Mountain shares have lost half their value, including a 20% drop through the first three days of this week. And if anything, the competitive landscape has gotten even busier in the past three months, signaling GMCR’s future domination of the single-serve coffee market is no sure thing.
Two main patents for Green Mountain’s famous K-Cup single-serving coffee pods expire in September 2012. After that, expect a donnybrook to break out as competitors horn in on GMCR’s territory. However, Green Mountain owns at least 37 patents on the appearance and construction of the pods, so it’s difficult to assess the value of these two specific patents.
Of course, that might not even matter. InvestorPlace Editor Jeff Reeves pointed out in October that Rogers Family Co. — an independent coffee roaster based in Lincoln, Calif. — already is selling a single-cup pod under the San Francisco Bay brand that is fully compatible with the Keurig system. In addition to Rogers Family selling these pods on their website for $6.99 per 12-pack, they’ll also be available at Costco (NASDAQ:COST), Safeway (NYSE:SWY) and other grocery stores.
In November, Bloomberg quoted analyst Mark Astrachan of Stifel Nicolaus & Co. as saying this about the direct competition: “The recent rollout of a Keurig-compatible pod from Rogers Family will negatively impact longer-term K-Cup profitability.” This is just the tip of the iceberg.
When Starbucks (NASDAQ:SBUX) and Green Mountain announced their partnership in March, many pundits wondered why the coffee giant didn’t just buy the Vermont-based company instead. They argued that 80% of Starbucks customers don’t own a single-serve machine, making them ideal candidates for both the machine and its pods. That’s a nice thought. However, the cost of that acquisition would likely have been close to $9 billion given the price of its stock immediately prior to the announcement. It made no sense investing that kind of capital when there was a real possibility that other systems were equally capable of brewing single-serve coffee.
Nine months later, and the pundits have egg on their face as it has become abundantly clear this partnership isn’t going to be as rewarding as first thought. Keurig is suing Rogers for patent infringement. From a Starbucks perspective, it would be a lot less expensive to buy Rogers, notwithstanding the litigation it would face from Green Mountain.
Hedge fund manager David Einhorn believes Green Mountain’s market share has peaked and is thought to be shorting its stock. Stifel Nicolaus is also bearish on Green Mountain’s future, giving it a sell rating because of weakening sales. According to Astrachan, shipments of the Keurig machine, which is made in China, declined by 5% in October and 28% in November, suggesting a deceleration of sales is under way. With inventories double what they were a year ago, it’s certainly possible. Furthermore, analyst Greg McKinley of Dougherty & Co. believes more Americans are buying coffee machines other than the Keurig brand these days, suggesting the bloom is off the rose.
Is Green Mountain a fad? If you believe single-serve coffee is here to stay, your answer has to be “no” despite the increased competition. On the other hand, if single-serve coffee portions never get past 8% of the entire coffee market, Green Mountain returns to being just another coffee roaster.
Worst-case scenario: Starbucks bolts from the partnership. That would be the kiss of death for Green Mountain’s stock. Don’t think it will happen? Starbucks terminated its relationship with Kraft (NYSE:KFT) in 2010 at a possible cost of more than $1 billion in termination penalties. If Starbucks CEO Howard Schultz’ isn’t getting a reasonable return on his investment, he won’t hesitate to back out of the deal.
Unfortunately for Green Mountain, it doesn’t have a Plan B.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned stocks.