This Market Needs Some Prozac – Part 1
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I've never seen such a blatant overreaction to news in my life as in the last few weeks. For me it started with Green Mountain Coffee (NASDAQ: GMCR). The company reported earnings that were cause for concern and the stock dropped nearly 50% in one day. Really? So the company was worth say $8 billion one day, and disappointing earnings caused half of the value of the company to disappear. Let's get real, there was panic selling that caused more panic selling. Let's examine this “disastrous” (hear the sarcasm?) report and see just what caused $4 billion in market cap to disappear overnight.
In a recent article, Rick Munarriz of The Motley Fool described some of the challenges to bull and bear cases for Green Mountain. His ultimate conclusion was the bulls don't have a perfect argument, and neither do the bears at this point. The rumor that Green Mountain could be a takeover candidate at these levels is another consideration. The top line numbers everyone pretty much knows, 37% sales growth and 33% increase in EPS. However, if you get beyond the headline numbers the picture is a little different.
I've written before that worries about a plateau in K-Cup sales were overblown. I still maintain that premise. In my last post, I showed how K-Cup sales have decelerated, but the growth percentages are still huge. In the first three quarters of 2011, the average growth in K-Cup sales was 93%. In the last three quarters this average has dropped to 57.66%. The reason is simple, buying K-Cups is not something that happens every single month or even every three months. There is a seasonality to this business. K-Cups are cheaper in bulk purchases. As more consumers buy a Keurig machine there will be an even greater swing to these numbers. For instance, if a consumer uses 1 K-Cup a day for their morning cup of coffee they need 30 or 31 K-Cups during the average month. While many consumers buy in the normal 12 – 18 count boxes, a lot of consumers have gotten smart and buy 48, 96, or even higher count packages. This does two things for the consumer, first it avoids having to constantly buy K-Cups. Second, it affords the consumer a slightly lower price per K-Cup. It's highly likely that this will continue to happen, causing wilder swings in K-Cup sales with these seasonal buys. Think logically, if a consumer buys 96 K-Cups at once and they use 1 per day, when will they need another box? Three months is exactly right. Since they won't buy for three months, the company will see a large jump in sales, followed by a drop because of this behavior. With 47% more K-Cups sold after a quarter where 78% more were sold, this pattern makes a lot of sense.
A second persistent worry is, that the sale of brewers will slow down. That has not been the case yet. Brewer sales have followed an almost perfect seasonal pattern in the last six quarters. The first quarter, which includes the holidays, showed 2 million brewers sold in 2011 and 4.2 million in 2012. The second quarter last year showed 1.2 million in sales, this year 1.4 million. With 16% more brewers sold in the second quarter of 2012 than last year, there in theory are 1.4 million more people who will need to buy K-Cups. From the company's own figures, in the last six quarters they have sold about 11.1 million brewers. This does not account for any licensed brewer sales by other companies. With roughly 90 million coffee drinking households as the target market, Green Mountain has just 12% of their market so there is still plenty of room for growth.
While the concerns about the Starbucks (NASDAQ: SBUX) Verismo machine have been trumpeted, what was lost in this quarterly report is that Green Mountain is going to be introducing its own espresso based machine in time for the holidays. The main problem with the Verismo to Keurig comparison is they don't compete for the same customer.
Where the new Green Mountain VUE machine is concerned, I'm amazed at the lack of thought put into certain comments. One comment in particular that seemed very short-sighted, was made by Motley Fool's own Austin Smith. He said that if the VUE system wasn't expected to have material sales this year, that he would assume “this year” means “never”. The problem I have is Austin apparently didn't quite think this through or read the company's statement clearly. First, the VUE only went on sale in March, the idea that it would have any impact on the quarter ending in March is foolish (small f). The fact that the company said that VUE sales “are not expected to be material in the Company's 2012 fiscal year 2012” is mis-understood. Green Mountain's fiscal year ends in September. The idea that the VUE system would be material when it launched in March and the fiscal year ends in September is again foolish (small f).
Another of Austin's comments was consumers have no reason to upgrade to the VUE. First, the point should be made that later this year the traditional Keurig and the VUE will occupy the same shelf at retailers. The VUE is a top-end machine and can do several things that the traditional Keurig can't. For instance, the VUE can brew lattes and cappuccinos, the Keurig can't. The VUE brews hotter and stronger coffee, which has long been a complaint about the Keurig. Finally, the VUE brews larger sizes like travel mugs, which the traditional Keurig doesn't do. There is a reason to switch, but until the VUE is sitting next to the traditional Keurig machines consumers won't make the choice yet. In addition, there is only one VUE machine (with more to come) versus there are 10 different traditional Keurig devices alone.
Now for the most fascinating part of the earnings announcement. The company expects $2.40 to $2.50 per share in earnings instead of up to $2.65 which was previous guidance. At best, this means the company will make 5.66% less, at worst we are talking about a miss of 9.43%. This is why the stock dropped 50%? With the stock selling for $24.91, you can buy GMCR for about 10 times expected earnings. While growth going forward might not match the previous earnings growth rate of 95%, do investors really believe this company will stop growing? At 10 times earnings, the stock is as cheap as I've seen in the last multiple years. Does everyone think that the 11 million people who own a Keurig are all just going to stop buying K-Cups? In the last quarter, 47% more K-Cups were sold versus last year. Does that sound like a company that is doing terrible? There are a lot of worries about Green Mountain, but after the recent decline, it seems like investors need to calm down and realistically assess the situation. Things aren't as dire as they are being reported to be.
MHenage owns shares of Green Mountain Coffee Roasters. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services recommend Green Mountain Coffee Roasters 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. If you have questions about this post or the Fool’s blog network, click here for information.