6 Reasons Not to Buy Green Mountain on the Selloff

NEW YORK ( TheStreet) -- Shares of Green Mountain ( GMCR) tanked by 16% on Friday after the Starbucks' ( SBUX) announcement of a single-serving coffee brewing machine, but this is no buy-on-the-dip opportunity.

Starbucks' announcement Thursday that it's stepping onto the home brew turf of its current partner Green Mountain and launching its Verismo single-cup coffee system could be an earnings-killer for Green Mountain and its Keurig home brewing empire.
Starbucks brews a bitter cup for its current partner Green Mountain Coffee Roasters.

Stifel analyst Mark Astrachan, one of the few analysts on Wall Street to be early and correct in advising investors to sell Green Mountain shares last year, laid out six reasons why the Starbucks announcement will produce much more pain for Green Mountain beyond Friday's selloff and why investors should continue to sell shares. In early 2012, Green Mountain shares bounced back after a major 2011 slide, but Astrachan sees Starbucks brewing a bitter future for Green Mountain.
  • 1. The Starbucks Verismo substantially undermines the pending Keurig Vue system, Green Mountain's answer to the September 2012 expiration of two principal K-Cup patents.
  • "This will result in K-Cups remaining GMCR's dominant platform, on which we anticipate considerable profit pressure due to competition from private label, partner brands, and other branded coffee companies," said Stifel analyst Mark Astrachan. "Further, given Starbucks' brand and distribution strengths, we anticipate Verismo will take share of the single-cup market. We anticipate this will negatively impact Keurig household brewer penetration, reducing GMCR's long-term earnings power."
  • 2. Starbucks is pricing its Verismo pods in line with its K-Cups, and that places Starbucks into competition with itself, which implies several negatives for Green Mountain.
  • 3. Starbucks could de-emphasize its relationship with Green Mountain in favor of its own higher profitability system.
  • 4. Starbucks could also try to gain negotiating leverage with Green Mountain when its current agreement expires.
  • Margin erosion at Green Mountain as it comes to rely more on sales of premium K-cups like Starbucks has always been a concern.
  • 5. Starbucks Verismo may impact the brand allure of the Keurig system in its key distribution outlets.
  • "Interestingly, higher price points on Verismo may result in consumers perceiving the K-Cup system as a mid-tier or value offering, which could force GMCR to increasingly compete on price, potentially reducing prices on brewers and/or K-Cups. Additionally, we believe retailers could reduce Keurig shelf space given Starbucks anticipates selling Verismo brewers and pods in many of the same channels (e.g., specialty stores like Bed Bath & Beyond and in FDM)," Astrachan wrote.
  • 6. Starbucks has a big cash advantage.

Starbucks said it would not have capital expenditures associated with Verismo, implying partner Krueger is paying for manufacturing and other start-up costs, Stifel assumes. This allows Starbucks to invest more dollars behind the Verismo launch.

Green Mountain, on the other hand, spent $91 million on advertising in fiscal 2011 compared to $283 million in capex and anticipated fiscal 2012 capex of $630 million to $700 million, including approximately $100 million to-date on its new Vue system.

Trading in Green Mountain Coffee Roasters has been volatile since Greenlight Capital hedge fund manager David Einhorn, famous for his short positions, revealed a major short position in Green Mountain last year and laid out what he views as accounting irregularities at the coffee company in a Powerpoint presentation titled "GAAP-uccino."

The once go-go momentum stock tanked, but also rebounded as part of the "junk" rally of 2012, which saw stock market dogs from First Solar ( FSLR) to Netflix ( NFLX) rise sharply in January and February.

The latest volatile trade in Green Mountain has to be viewed in the framework of its big run-up this year. Shares started the year at under $45 and had been as high as $69 earlier this month, Even after the 16% selloff on Friday, shares are still up 17% this year.

With much of the Green Mountain shareholder base concentrated in institutional funds that do not change positions quickly, mass profit-taking on the negative Starbucks headline from investors who bought after the massive slide in 2011 is no surprise.

The real issues for Green Mountain will come well after Friday's bad day if Astrachan is right. When it comes to Green Mountain, he has been on the right side of the trade before.

-- Written by Eric Rosenbaum from New York.

>To contact the writer of this article, click here: Eric Rosenbaum.

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