Are These 4 Coffee Stocks Attractively Valued?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Green Mountain Coffee Roasters (NASDAQ: GMCR) shares rose to around $37 Nov. 29 on higher fiscal fourth quarter income from increasing K-cup sales. This spike in share price makes Green Mountain Coffee Roasters less attractive as an investment. Its price multiples are now just reasonable, like those of McDonald's (NYSE: MCD). Though still cheaper than Dunkin' Brands Group (NASDAQ: DNKN) and Starbucks (NASDAQ: SBUX), Green Mountain Coffee Roasters is no longer a compelling buy stock.

Excellent Results

Net income for the quarter ending Sept. 29 surged to $91.9 million (58 cents per share) from $75.4 million  (47 cents per share), a surprising 22% increase compared to analysts’ average estimate of flat growth at 48 cents. With revenue increasing 33% to $946.7 million and beating analysts’ estimate of $904.7 million, the company raised next fiscal year’s forecast to $2.74 per share from $2.65 per share earlier.

CEO Lawrence Blanford’s introduction of a new Keurig machine that makes milk-based drinks and an espresso maker co-developed with Luigi Lavazza are cited as driving forces for the sales surprise.

The company announced earlier that Coca-Cola executive Brian Kelly is set to take over from Blanford this December. Analysts see Kelly’s experience with bottling and dealing with food and drug retailers would be beneficial, adding momentum for the company.

Green Mountain plans to add more K-cup licensees after introducing several strategic moves this year: the Vue machine for making lattes and cappuccinos, the Rivo brewer to match up with Nestle’s (NESN) Nespresso makers, and arrangements to make single-serve cups for Costco Wholesale (COST) in Breakfast Blend and Pacific Bold varieties, among others.

Green Mountain is not without problems. Since the company’s main patents for K-Cups were set to expire in September, grocery stores making private-label capsules and Starbucks with Verismo - its own version of single-serve coffee maker are likely to become competitors. Hedge fund manager David Einhorn said the Verismo “is part of the competitive onslaught hitting Green Mountain.” Einhorn criticized the company for lack of transparency and dubious accounting practices.  After a SEC investigation in September 2010, Green Mountain restated its earnings for four consecutive fiscal years, 2007 to 2010 citing accounting errors including overstated pre-tax income.

McDonald’s Downgraded

Even though McDonald's is widely regarded the leader of the fast food business, recently it has been going through a hard time in the stock market. There have been several concerns about the company's future direction, the latest of which came from what Lazard Capital called the "abrupt firing" of Jan Fields, McDonald's USA President.

The company has denied a connection between Field's exit and slow sales at its food outlets. This is difficult to believe considering how October's European and US restaurant sales marked its first monthly drop in nearly 10 years. As well, there haven't been any changes in its menu or modifications of its advertising campaigns, strategies that have already been implemented by nearly all of its largest competitors. This seems to have also translated in flat sales growth during the last two quarters.

A week after McDonald's announcement of Field's departure, Lazard Capital downgraded its recommendation from buy to neutral, which took a toll on the shares of the hamburger giant. The reaction from the stock market to the downgrade was a dip on its shares of nearly 10% since its recent high of $95 on Oct. 16.

Starbucks Acquisitions

Starbucks is buying Teavana Holdings (NYSE: TEA) for about $620 million. This tea company is the biggest acquisition ever for Starbucks and would take the company beyond its core area of coffee and namesake shops.

Growth through acquisition should give investors pause. This strategy is expensive and has historically done poorly for acquiring companies. If we are capable of learning from the past, then we should expect the combination of firms through acquisition to result in a host of problems. Investors should stay away from Starbucks given its current strategy and valuations in favor of other related stocks.

Since 2008, when Schultz returned as CEO to the company, the company has made moves to sustain its sales growth by selling juice, instant coffee, a single serving brewer, and energy drinks. Starbucks has also removed the word ‘coffee’ from its logo. Starbucks makes lots of acquisitions. In 1999 it bought Tazo tea. Last year Starbucks bought Evolution Fresh for $30 million and this year it purchased Bay Bread for $100 million.

Teavana investors will get cash of $15.50 per share as part of the takeover. The takeover is expected to happen by the end of the year. This would also add about 1 cent per share in earnings to Starbucks’ fiscal in 2013. The purchase price at which Starbucks bought the company is 17.5 times trailing EBITDA.

You should need considerable convincing before buying acquiring firms for many reasons. First, acquirers often to pay too much for the companies they buy. Second, many business combinations create culture clashes and discover other hurdles to integration. Hoped-for synergies are often not realized. Third, the firm becomes bigger and harder to manage after completing an acquisition. As a result, many firms end up spitting out acquisitions. Investors should be aware of should only buy acquiring firms if they are trading at very cheap valuations.

Valuation

Neither Starbucks nor any of its peers are trading at truly compelling valuations:

Ticker

Company

P/E

P/S

P/B

P/FCF

DNKN

Dunkin' Brands Group

44.19

5.05

10.57

44.35

GMCR

Green Mountain Coffee Roasters

16.9

1.57

2.58

NA

MCD

McDonald's

16.39

3.18

6.3

81.84

SBUX

Starbucks

28.98

2.9

7.62

110.11

Green Mountain Coffee Roasters and McDonald’s are both trading at slight premiums to the average 14 price-to-earnings ratio of S&P 500 stocks. Both stocks trade at higher price-to-sales ratios than the index, too. Each firm is in the dog house with analysts, and should trade at a discount instead of at a premium.

Starbucks and Dunkin’ Brands Group are terrible stock investments at today’s price multiples. They are glamour stocks and should be ignored until their prices come down.


BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's, Starbucks, and Teavana Holdings and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters and short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Green Mountain Coffee Roasters, McDonald's, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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