Now Time for a Little Perspective
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When Green Mountain Coffee (NASDAQ: GMCR) reports earnings, you know it's going to be an interesting afternoon.
I didn't see the exact moment that earnings came out, but I do know that on Twitter both Herb Greenberg of CNBC and Alyce Lomax of The Motley Fool were quick to comment on what they saw as negative information from the earnings report. There are two prevailing opinions on Green Mountain. On the one side are investors that believe that Green Mountain represents a good value play after the stock imploded over the last several months. On the other side, some investors have been waiting for Green Mountain to fall from grace. In reading through the earnings report, while Green Mountain may no longer be a hyper-growth company, there are quite a few positive signs that the company could do well from here.
The company reported net sales up 21.19%, and diluted EPS up 24.32%. Something I have not seen mentioned is that foreign currency adjustments hurt net income by over $14 million, so net income could have been up by more than 29%. Since the company reports in three different divisions, let's take a look at each to see exactly what happened in the most recent quarter.
One bit of advice I would give Green Mountain management is please change the abbreviations or name of their divisions. The company specialty coffee business is designated as SCBU, while the other divisions are called KBU (Keurig), and CBU (Canadian) sales. I know it's a minor point, but using this many similar abbreviations is both confusing and unnecessary. For a company facing so many questions about its future, I'm sure many investors and analysts would be more than happy just calling the divisions by their proper names.
That being said, the specialty coffee business, which sells K-cups and Vue packs, saw revenue increase by greater than 40%. Because of pricing pressures, income before taxes increased 36.5%. K-cup sales specifically increased by 51%. For a bit of perspective, consider the fact K-cup sales in the same time frame last year increased by over 120%. I don't say this to point out how much slower this year's growth was, but to make the point that a 51% increase on top of a 120% increase last year is tremendous growth. As you can see, the company's most profitable division actually turned in a very good quarter, and yet almost no one is talking about this portion of the earnings report. Looking at the Keurig Brewing Unit, we will see that while there were challenges, there is some underlying strength here as well.
The KBU unit, which for simplicity sake could just be called Keurig, showed revenue of 16.65%. However, income before taxes decreased 40%. Initially this looks really bad, however, the actual reason has a lot to do with the fact that the company is just beginning to mass produce its new Vue brewer. The company mentioned that they sold over $20 million worth of this brewer and compatible packs. In addition, the company plans to introduce multiple lower-priced new models by the fall. The traditional Keurig lineup saw growth, with 1.5 million units sold during the quarter. For a bit of perspective, last year the company sold just over 1 million units during the same quarter. Brewer sales are highly seasonal, and traditionally speaking the fourth and first quarters are the strongest of the year. These 1.5 million new brewers address an issue of inventory levels that has been brought up multiple times. We'll come back to the inventory question after looking at the company's Canadian unit.
The CBU or Canadian brewing unit, showed revenue down 4.35%, and income before taxes down 4.45%. This appears to be a problem area until you read the detailed information. The company sold its FilterFresh unit last year, and the loss of this unit cost the company $29.4 million in the current quarter. This more than offset the 38% increase in the sales of K-cups, and the 42% increase in brewer sales. Educated investors understand that this is an anomaly that will disappear next year. With a better than 35% growth rate in both brewer sales and K-cup sales, the Canadian unit is actually doing very well. Now that we've covered the three units, let's take a look at the company's financials.
One of the biggest issues I've heard mentioned was the increase in the company's inventories on a year-over-year basis. In fact, Alyce Lomax of The Motley Fool recently wrote, that she didn't understand how 60% inventory growth could be a good thing. She specifically said that surging inventories to stock up for the holiday season didn't make sense because of the sluggish economy and skittish consumers. To answer Alyce's question, one only needs to realize that the company sold 1.5 million new brewers, and the two strongest quarters for the company are coming up in the next 6 months.
In addition, while inventory did increase 60% on a year-over-year basis, it was actually down slightly versus a few months ago. The best way to think of the company's inventory stockpile is in relation to total number of brewers. In the same way that a retailer has to carry higher inventory levels with more locations, Green Mountain must carry higher inventory levels to support the additional brewers. Hopefully this settles the inventory issue. Setting this issue aside, Green Mountain increased its cash by 40% and cut its long-term debt by 30% on a year-over-year basis. The last issue to resolve is what may happen when the company loses its K-cup patents.
Green Mountain's two primary competitors are Starbucks (NASDAQ: SBUX) and Dunkin' Brands (NASDAQ: DNKN). Both of these companies have entered into “multi-year manufacturing and distribution agreements” with Green Mountain. The Starbucks relationship began in March 2011 and was expanded in March 2012 to include the new Vue system. The Dunkin' Brands relationship started in February 2011 and was expanded in February 2012, also to include the new Vue system. Considering these are both multi-year relationships, it's highly unlikely that sales of these brands will change much when Green Mountain's K-cup patents expire.
In addition, Green Mountain directly owns many of the most popular K-cup brands. Sales of these K-cups should not change at all. The worry about private label competition from grocers such as Safeway and Kroger is a small issue, as coffee drinkers choose based on taste, not solely on price. While it's true that Green Mountain cut its full year 2012 and full year 2013 estimates, the company still is projecting a higher growth rate than either Starbucks or Dunkin' Brands.
Starbucks sells for about 20 times forward earnings expectations and gave revenue guidance of between 10% and 12% growth. Dunkin' Brands also sells for over 20 times earnings and sees revenue growing at 7% to 8%. Green Mountain still sells for just 10 times the company's worst EPS projection and is projecting 15% to 20% revenue growth.
While the stock may never recover to trading for a P/E ratio above 30 or 40, if the company delivers on its expectations, it seems unlikely that it should stay at just 10 times earnings either. Investors have the opportunity to use the drop of the last several months to their advantage by adding some green to their portfolio.
MHenage owns shares of Green Mountain Coffee Roasters. The Motley Fool owns shares of Starbucks and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters and short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters. 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.