Breaking the Caffeine Habit
For years, investors seemed as addicted to Green Mountain Coffee Roasters (symbol GMCR) as customers were to its joe. From a split-adjusted low of $2.80 in 2006, the stock soared to $116 before peaking last summer. But the price has been sliced in half since hedge-fund manager David Einhorn publicly made a case against the stock. His reservations: Growth opportunities are limited; the expiration of patents will eat into its lucrative K-Cup business; and the firm's financial results aren't trustworthy. But have investors overreacted, and is the stock of this still very profitable company now a buy?
Green Mountain sells single-cup coffee makers and individual packets of coffee known as K-Cups, as well as roasted coffee. Profits took off after the firm bought Keurig, a maker of single-cup brewers, in 2006. Green Mountain, which earned $8.4 million, or 7 cents per share, in the fiscal year that ended September 2006, made $249 million, or $1.31 per share, in the year that ended last September.
But profits could be about to take a hit. The company's patents for its K-Cups, which generate about 70% of the company's profits, will expire next September. That will help private and branded labels steal market share, forcing the company to lower prices. Longbow analyst Alton Stump, who rates the stock a "buy," says the patent expiration won't be a problem in the next six to twelve months but will begin pressuring the company's earnings in 2013.
Now there's evidence that brewer sales could be slowing down. Stifel Nicolaus analyst Mark Astrachan, who rates the stock a "sell," says sales of Green Mountain's Keurig single-cup coffee makers are weakening, which will eventually hurt sales of K-Cups and depress profits. Astrachan says that in five of the past six quarters inventories of the company's brewers have increased faster than sales, and that more brewers are being sold at discount prices or through discount retailers. Shipments of Keurig brewers from China declined 5% in October and 28% in November compared with 2010, he says. These findings contradict management's comments that demand for coffee makers remains robust.
Bears assert that the company manages inventory and expenses poorly and has made its financial statements murky to hide deterioration of its business. They say spending is growing faster than the business, but management has been vague about where the money is going.
Underscoring those concerns, the Securities & Exchange Commission has been investigating Green Mountain for more than a year for problems with accounting disclosures -- notably for sketchy revenue-recognition practices and overstating profits. Making matters worse, law firms Briscoe and Powers Taylor brought a lawsuit against Green Mountain in December, alleging that the company's officers and its board of directors misrepresented and failed to disclose that firm vendor M. Block & Sons housed excess inventory and expired products, and that Green Mountain overstated its sales and assets.
"This thing will not blow up and go to zero," says Whitney Tilson, founder and managing partner of investment management firm T2 Partners, who is shorting the stock. But, Tilson says, "it's hard to tell how much of this is poor systems and controls versus a deliberate attempt to deceive investors." Tilson thinks the stock will fall at least as low as $30 a share.
Bulls argue that K-Cup sales are picking up now that Green Mountain sells them in grocery stores, Walmart and Starbucks instead of only online or in specialty retailers, such as Crate & Barrel. The number of K-Cups shipped rose 75% in fiscal 2010 from fiscal 2009 and 80% in fiscal 2011 from 2010. They also think there's room for Green Mountain to expand its business outside its core Northeast market into the rest of the U.S. -- particularly the West Coast. Plus, they say deals to sell K-Cups branded for Smucker, Dunkin' Donuts and Starbucks will boost profits.
But with more competition coming, brewer sales potentially weakening, and an accounting cloud hanging over the company, investors expecting more double-espresso jolts of profits are likely to be disappointed and should avoid the stock.