CBOU: THE CURSE OF GMCR

That title may seem slightly hyperbolic, but Caribou makes money from selling green coffee to Green Mountain; they will feel the impact of any further issues that arise for GMCR.  The recent short squeeze, taken out of context, could be taken as a vote of confidence in Green Mountain; rather, we feel that the squeeze represents another compelling opportunity to short a stock that has some way to go before being fairly valued.

We will be writing up a comprehensive note on GMCR in the coming days but thought that some comments from the CBOU earnings call last night were worth highlighting.  “Significantly reduced shipments of green coffee to Green Mountain Coffee Roasters”, as Caribou management discussed, was a drag on revenue growth in 2Q12.  Green Mountain seems to be reducing its inventory levels of Caribou coffee.  We see this as the beginning of a larger inventory correction phase for Green Mountain, and the drawdown will be a drag on earnings going forward. 

CBOU: THE CURSE OF GMCR - GMCR sales inv

As for other players in the single-serve category, it is difficult to draw direct conclusions from the Caribou commentary, but it seems likely that Starbucks gaining market share could have exacerbated the decline in sales volume that CBOU is experiencing.  Despite this, our view is that the numerous landmines buried in Green Mountain’s outlook could also have a negative impact on Starbucks’ earnings. 

Below are a selection of quotes from the Caribou earnings call that highlight some issues for CBOU and GMCR.  For Caribou, the positioning of its brand within the Green Mountain portfolio can have a significant impact on its volumes; we believe this is a dynamic to watch closely going forward, particularly as Green Mountain’s K-Cup patent expires.

[INVENTORY] “I would say that as we talked on Q3, it will be the greater impact because that's where we're feeling the biggest shift in lower green coffee sales as Green Mountain is managing down their weeks of supply. So it's clearly more heavily weighted in Q3 than in Q4 and I would put the range or the delta on a quarter-over-quarter basis in that 40% recognizing that a big part of that is the green coffee that normally would have shipped that won't be going through in Q3.”

HEDGEYE:  That Green Mountain has an inventory problem should not be a revelation to anyone; the severity of the problem is the most important point.   We would take this quote as indicating that Green Mountain is likely managing its inventory levels due to lower sales volumes.  This has significant implications for Green Mountain’s business in 4Q12 and FY13.  In 3Q12, Green Mountain’s inventory grew 60% while sales increased 21%.   We see a heightened risk of GMCR taking a charge over the next couple of quarters (likely in January) and missing EPS expectations.

[THE SBUX EFFECT] “We are now expecting a decrease of approximately 10% for the year in Caribou branded portion packs. This decrease is driven by a combination of single serve category dynamics, as well as some short-term factors driving Caribou performance specifically. At the category level, new brands have entered the single-serve space, particularly at the premium end of the spectrum and are taking share from all leading players, including Caribou.”

HEDGEYE:  Starbucks’ market share gains are contributing to the decline in Caribou’s performance.  This also raises the question of whether Starbucks is taking share from Green Mountain in the single-serve category.  We would posit that the emergence of Starbucks into the category is leading to Green Mountain’s incremental sales growth to be less profitable (if we assume that Starbucks portion packs are less profitable for the company than Green Mountain’s).

[VOLUMES] “At the same time, Green Mountain has seen greater than expected channel shifting across their portfolio as volume has moved from the specialty retail channel into the more traditional grocery outlets. This shifting has affected all brands in the category and while we are seeing Caribou volume increases in the grocery and away-from-home channels, it's not been sufficient to offset declines in the specialty retail and club channels.”

HEDGEYE:  It’s difficult to tell if the shift described above is down to a change in consumer preference or a self-inflicted wound stemming from mismanagement.

[LICENSOR-LICENSEE] “Additionally, in the early part of this year, the Caribou brand was repositioned within the Green Mountain portfolio to more premium pricing group.  The Caribou brand can command a premium price from consumers, but the retail implementation of the Green Mountain pricing strategy is having a meaningful impact on our club volume, at least, in the near term. This channel represented a large portion of our total business and is the primary driver of our actual and forecasted volume declines.”

HEDGEYE: This is likely a point of contention between Caribou and Green Mountain: it appears that Caribou has little control of the retail pricing of its brand, at least in club channels, and suggests that Green Mountain may be taking measures to increase the rate of sales growth of its own brands.

Howard Penney

Managing Director

Rory Green

Analyst