Starbucks (SBUX) Takes Aim at Green Mountain (GMCR) and Nestle

Last week, Starbucks (SBUX: Charts, News) unveiled the Verismo, a single-serve brewer squarely aimed at a market dominated domestically by Green Mountain Coffee Roasters' (GMCR: Charts, News) popular Keurig brewers and its patented "K-Cup" technology.

Shares of Green Mountain, a momentum favorite which has increased over 600% since 2009, crashed nearly 16% on Friday as investors jumped ship on the news.

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Surprisingly, Starbucks also develops single serving K-Cups for Green Mountain, a partnership it expects to continue. CEO Howard Schultz clarified the company's position, stating that the company is not intentionally treading on Green Mountain, but rather is attempting to carve out a niche that Green Mountain and Nestle have successfully occupied for the past few years. Nestle's Nespresso machines are currently the most popular single-serve brewers in Europe. Although Green Mountain's Keurig brewers accept Starbucks' K-Cups, Starbucks' machines won't be compatible with Green Mountain's K-Cups, hinting at inevitable disputes further down the road.

Starbucks claims the Verismo brewer is the culmination of its instant coffee strategy, which started three years ago with the introduction of its best-selling Via single-serving instant coffee. Via, which sells for an average of $1 per packet, was initially introduced as a hedge against rising coffee bean prices. It has since grown into a $1 billion business, claiming a 12.5% piece of the world's $8 billion instant coffee market.

Starbucks' Verismo will be manufactured by Kruger, a private German company, while the coffee and milk pods will be produced by Starbucks. The pods will consist of Starbucks' own coffee and a "shelf stable" dairy pod that "tastes like fresh milk". With the Verismo, Starbucks is likely to adopt the same "razor and razor blades" business model that helped Green Mountain succeed, selling brewers at a thin margin in order to sell more higher-margin serving cups. However, whereas Green Mountain's Keurig is a low-pressure brewer that creates an assortment of coffee beverages, Starbucks' Verismo is a high-pressure one focused on espresso-based drinks. Starbucks management stated that the machine is "expected to revolutionize the at-home espresso market".

The Verismo will be available in the fall, at high end specialty stores and select Starbucks stores within the United States. Starbucks wants to make sure that the Verismo will be widely available by the holiday season, where approximately 50% of single-server brewer sales occur. With an improved outlook for the economy and rising consumer sentiment, that number may even be higher this year. While some analysts are concerned that Starbucks may cannibalize its own products, specifically its Via instant coffee and brick-and-mortar sales, investors showed surprising faith in the company, pushing the stock to all-time highs north of $50 at the end of last week.

At these levels, the stock's trailing P/E of 31 is getting expensive for cautious investors. Even Green Mountain, known for its high multiple, now trades at a modest 27. Green Mountain posted 101.7% year-over-year sales growth last year, while Starbucks grew at a more modest 16.4%. However, Starbucks' Verismo is predicted to reverse this tide. It's also worth noting that Starbucks' biggest threat, McDonald's (MCD: Charts, News), is trading at 18.4 times trailing earnings despite rising 27% over the past twelve months, and is widely considered the cheaper stock by most analysts. McDonald's net margin of 20.4% is also nearly double Starbucks' 11.1%. McDonald's McCafe coffee and dessert menu have become a popular, cheaper alternative to Starbucks - a strong selling point in uncertain economic times. Both McDonald's and Starbucks have flourished in Europe despite adverse macro factors.

Other News About SBUX
Starbucks raises prices on a premium brew
Starbucks raises prices to keep up with commodity costs.
Starbucks Up 3%, Single-Cup Brewing Green Mountain Shares
Starbucks surprises the market with its Verismo brewer. Other Stocks in the News
Why McDonald's Will Keep Winning
Despite a recent drop, analysts are still bullish on the golden arches.
Is Apple in danger of antitrust charges?
Is Apple about to be taken down a notch like Microsoft?

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Published on Mar 13, 2012
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

Copyrighted 2020. Content published with author's permission.

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