K-Cup Maker Brews Up Profit With Push To Single-Serve Coffee

• Norm Alster
• On 6:14 pm EDT, Tuesday October 13, 2009

They don't have quite the brand- name recognition of iPods. But K-Cups seem to be making a spirited challenge to the Apple devices for the title of hit product of the decade.

So what are K-Cups? And how is it that they have propelled shares of Diedrich Coffee from a close at 31 cents on March 16 to a recent price of nearly 25 a share?

K-Cups are single-serve packets of coffee designed for Keurig single-cup coffee brewers. The brewers are made by Green Mountain Coffee Roasters of Waterbury, Vt. Irvine, Calif.-based Diedrich is one of four Green Mountain licensees that make the disposable K-Cups for the brewers.

Sales Steaming

Sales of both the brewers and K-Cups are at full boil. Green Mountain reported sales growth near 60% last quarter. Diedrich last quarter reported 57% revenue growth, leading to only its second profitable quarter in the last five years.

K-Cups account for more than 90% of Diedrich revenue. Diedrich expects revenue for its fiscal year ending June 30, 2010, to reach $90 million to $95 million. That's up from just $62.3 million in fiscal 2009.

Anton Brenner of Roth Capital Partners is the only independent analyst known to cover Diedrich. He expects Diedrich to report 48% revenue growth to just over $92 million for fiscal 2010. Earnings should come in at $1.00 a share, compared with a 5-cent profit in fiscal 2009.

For fiscal 2011, Brenner forecasts sales of $118 million. That should produce a 75% gain in EPS to $1.75, Brenner estimates. Until K-Cups led Diedrich to profitability the last two quarters, the company had not been in the black since the June quarter of 2004.

So what is the appeal of single-cup coffee makers? And what reason is there to believe this product can keep flying off retailer shelves?

"You can make a cup of high-quality coffee very quickly. It's easy and convenient and there is no cleanup," said Jon Andersen, who follows Green Mountain Coffee for William Blair.

Brenner says he rises very early in the morning and likes the convenience of not having to brew a whole pot. "This is easy. It takes 30 seconds," he said.

It should be noted first off that the Keurig single-serve brewing system is not cheap. Prices begin around $90 but rise on the top-end units to about $250. On Amazon, a 24-count K-Cup package of Diedrich Colombian coffee was recently advertised for $23.

Diedrich sells on Amazon and through Green Mountain. Originally marketed for office use, Diedrich has steadily expanded distribution.

The California coffee roaster has been offering K-Cups at specialty retailers like Bloomingdale's and Bed Bath and Beyond . K-Cups can now also be found at Kohl's , Target and Costco . Early this year, Diedrich signed on with Wal-Mart .

But Brenner says the market for single-cup brewers and their K-cups has barely been penetrated. The real market will be for home use, and this market has barely been scratched. "Fewer than 3 million homes have Keurig brewers," Brenner said.

Most coffee maker sales for at-home use are through supermarkets. Diedrich has barely begun to sell through that channel. To date, says a Diedrich investor relations spokesman, there are no major supermarket chains carrying the Diedrich K-Cups. But penetration of the supermarket channel is "part of the strategy going forward," the spokesman said.

"Diedrich will ramp up their grocery effort," Brenner said. "I see this as a mass-market item."

One key question clouds the spectacular sales-growth numbers. With major new customers like Wal-Mart and Costco signing on, how much of the sales growth is simply the stocking of initial inventory by these giant chains?

"Initial orders are part of it," the Diedrich spokesman allowed. But he declined to break out sales growth in existing accounts. Analyst Brenner also could not supply figures. But he says there has been strong sales growth at older outlets. "Same-store sales are also increasing rapidly," he said.

Diedrich, in its SEC filings, concedes the risk that Green Mountain Coffee could move to enlarge the number of K-Cup licensees.

"They have the ability to do that," Brenner said. But he thinks such a move is unlikely since Green Mountain also sells its own K-Cups. Why create new competition?

"It may not be in their interest to increase the number of licensees," Brenner said.

Retail Stores Sold

Diedrich's success with K-Cups comes after the company abandoned its efforts to grow as a retail chain of coffee shops. Diedrich has divested itself of all its stores. Some were sold to Starbucks (NasdaqGS:SBUX - News), which now faces the prospect of competition from one-cup office and home brewers.

For K-Cups to sustain strong gains, the Keurig brewers will probably have to come down in price. To this end, Green Mountain has licensed low-end kingpin Mr. Coffee to make a new one-cup brewer. "They're trying to make the price-points more accessible," analyst Andersen said.

Brenner expects the Mr. Coffee version to have fewer bells and whistles. It will also have "a lot less metal and a lot more plastic," he said. A lower-cost Mr. Coffee version of the brewer could hit the market by Christmas, according to the Diedrich spokesman.

Buzz up!