Despite all the projected sales growth of single-serve coffee market, Keurig Green Mountain (GMCR, Financial) was in for trouble due to some strategic mistakes. The company misread consumer loyalty. Consumers don’t like the idea of their freedom of choice being taken away from them, and they are quick to disown even their favorite brands when that happens. Consumers have the biggest power – the wallet.
This is precisely what happened when Keurig launched the V 2.0 which took away the freedom that came with My K-Cup coffee brewing pods that allows brewing of non-Keurig coffee. This decision was indeed a disaster and the aftershocks translated into a dismal second quarter fiscal 2015 results, followed by a weak guidance. This indeed took the analysts and investors by surprise, and the stocks have declined over 23% year-to-date.
Let’s recap the numbers.
Dismal quarter
- Keurig Green Mountain's revenue came in at $1.134 billion with a marginal year-over-year increase of 2%. Analysts were expecting this number to be $1.16 billion. Although pod sales increased 7% year over year, a sharp 23% year-over-year decline in sales of brewers and accessories hit the top-line hard. In addition, negative impact of currency movements impacted the top-line by 1 percentage point.
- On the back of lower-than-expected top-line growth, earnings came in at $1.03 per share and missed the consensus estimates of $1.05 per share. In addition, this was lower than year-ago quarter by 5% due to soft revenues and lower margins.
- Gross margin contracted by 80 basis points, or bps, to clock 40.7% of net sales. In addition, adjusted operating margin declined by 170 bps to 22.9%.
- Net sales of other products declined 5% year over year as a result of demand shift from traditional coffee package formats to single-serve pods. On the other hand, net sales of Pods increased 7% year
From the results, I found that the management was just trying to put the blame on something invisible. Brian Kelley, president and CEO said during the earnings call, “And while difficult to forecast with precision, we estimate that total Keurig system volume would have been a few 100 basis points higher if we were manufacturing the pods for all Kraft brands.”
Fixing the problem won’t be easy
It is clear that customers didn’t like the idea of being locked down to Keurig-licensed pods, as that took away their freedom to brew coffee of their choice. Moreover, the high price tag of new Keurig 2.0 brewers and higher prices charged for the Keurig-branded pods also added to the problem. In addition, there were concerns about the amount of non-recyclable waste generated by the pods. These were credible concerns which Keurig Green Mountain failed to read.
As a part of damage control attempt, Keurig Green Mountain has decided to re-introduce My K-Cup coffee brewing pods that allows brewing of non-Keurig coffee with version 2.0 machines. As to how much this move will help win back customers is yet to be seen. But, I know that it will be an uphill task if we look at how American Eagle (AEO, Financial), Abercrombie & Fitch (ANF, Financial) and others in teen retail suffered when their target customers moved away.
Management is also aware that this is an uphill task, and this is evident from the reduced guidance for fiscal 2015. The company expects earnings per share to decline in mid single-digits. The negative impact of currency movements will add to bottom-line woes to the extent of $0.14. The top-line is expected to remain flat or inch up in low single digits.
For the third quarter, earnings are expected to be in the range of $0.75 to $0.80 per share, and top line will still struggle to grow in low single digits at best.
Wrapping up
Keurig Green Mountain clearly misread customer loyalty and in the end had to pay the price for ignoring certain credible concerns. In addition, the new brewer face intense challenges from rival coffee makers like TreeHouse Foods (THS, Financial), Rogers Family Co. and Canada’s Club Coffee. TreeHouse had sued Keurig for being anticompetitive. TreeHouse also announced that it has cracked the code for version 2.0 brewer.
Getting back on track looks like a long drawn affair. Also, one would need to watch if My K-Cup re-introduction is going to be permanent or is just a band-aid solution for the short term. Hence, investors are best advised to watch this stock from the sidelines for a quarter or two.
