The Brewing Single-Cup Coffee War

by Tony D'Altorio

The Brewing Single-Cup Coffee War

by Tony D'Altorio, Investment U Research

Monday, April 25, 2011

I recently discussed coffee's price hike up about 90% over the past year - to 34-year highs!

This dramatic increase sent coffee shops like Dunkin Donuts and Starbucks (Nasdaq: SBUX) for a loop.

The latter raised its packaged coffee prices by 12 percent, along with hiking cups of coffee too. But the entire industry knows all too well that it can't fall back on that coping mechanism for forever.

Eventually, java lovers will simply say, "Enough!"

Knowing that, Starbucks and Dunkin' Donuts have another plan that promises higher profit margins than its stores offer. Both are moving into the home, single-cup coffee market. And they intend to stay there for the long haul...

The Coffee Industry's Single-Cup Future

Dunkin' Donuts and Starbucks are racing to roll out premium coffee products for single-cup coffee machines.

Dunkin' - which claims to be the biggest U.S. coffee merchant, selling over 1 billion cups per year - believes customers crave it at home just as much as on their morning commutes.

So it took the initiative of making a deal with Green Mountain Coffee Roasters (Nasdaq: GMCR).

  • Green Mountain makes the nation's most popular single-cup coffee machines, with a 70 to 80 percent share of the U.S. single-cup market.

  • It built its business on proprietary technology that merges home coffee makers with its K-cup pods.

  • Since Green Mountain sells the actual machines for as little as $100, it really makes its profits on the individual cups, which retail for 60 to 80 cents each.

As announced in February, it plans to launch Dunkin' Donuts' flavors nationwide this summer. That puts Dunkin' ahead of Starbucks, whose similar deal calls for an autumn debut.

Both competitors expect U.S. consumers to jump on the ease of using single-serve pods. That includes the model's lack of waste as compared to traditional drip machines.

Starbucks, for one, is so confident in its new business that it believes this new venture will generate $1 billion in sales. But it might be counting its till a bit too fast...

Nespresso's European Single-Cup Coffee Competition

While Dunkin' Donuts and Starbucks prepare to duke it out in the U.S., Nespresso is popularizing single-cup coffee in Europe. Owned by the world's largest food company by sales, Nestle ADR (PINK: NSRGY), Nespresso has impressively high-profit margins.

As of now, the U.S. is merely its eighth-biggest market, though it has rapidly expanded its presence here. After a slow start, its sales doubled in the past three years.

Nespresso says that advance comes from good products, keen design and canny marketing.

And now, Nestle wants to push further in the United States, ss Nespresso CEO Richard Girardot says, "we know there is big potential."

Robust Coffee Business

Despite growing competition, there should be room for everyone to grow in this infant industry.

Portioned coffee accounts for only about 8 percent of the overall global coffee market. Yet it was still worth $2 billion last year and is growing fast.

No wonder then that Green Mountain trades like a high-flying technology company's valuation - at 53 times its forecast earnings for the next 12 months.

And like a technology company, its stock rocketed higher by 41 percent last month when Starbucks announced their partnership.

The single-cup coffee market should be a winner for all involved. At least for now.

As Larry Miller, an analyst at RBC Capital Markets, said, "If Starbucks can chop up its packaged coffee business into smaller packets that sell at five times the price, that's great for them."

The same holds true for Dunkin' Donuts and Nespresso... and their investors.

Good investing,

Tony D'Altorio

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