These 3 Trends Should Worry Investors

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

How many “smart” investors warned against missing the opportunity in Green Mountain Coffee (NASDAQ: GMCR) when the stock was going up? Yet those same “smart” investors were screaming for investors to get out of the stock when it started its freefall. Now this same group is saying the old Green Mountain is back. The truth is, the company is exhibiting three trends that should worry investors that are holding shares today. Unless the stock has a correction, it seems the “smart” money may be wrong again.

The Worst Is Over Right?
Investors who bought Green Mountain Coffee at its lows are probably rejoicing right now. There is no question there were several positives in the company’s latest numbers. Green Mountain reported a 58% jump in EPS that was driven by lower costs, and a 21% increase in the number of units of single-serve packs.

This strength in K-Cup sales is good news for two of Green Mountain’s partners: Dunkin’ Brands (NASDAQ: DNKN) and Starbucks (NASDAQ: SBUX). Both of these companies extended their K-Cup agreements Green Mountain, and should benefit for the next several years.

The company’s 11% revenue growth might be considered weak by some investors. However, considering that only Starbucks reported better revenue growth at 13%, this last quarter has to be considered a win. This is particularly true if you compare Green Mountain to Panera Bread (NASDAQ: PNRA) and their revenue growth of 11%.

Panera competes in the coffee industry with their lineup of beverage options, and is considered a champion growth story. The fact that Green Mountain matched Panera’s revenue growth rate should help reassure investors. When you consider that Dunkin’ Brands grew revenue by just 5.5%, Green Mountain’s increase looks very healthy indeed.

With Green Mountain reporting a 58% increase in earnings per share, it seems like investors are being treated to the type of growth that made the company a veritable investing legend. Even Starbucks’ 28% increase in EPS looks low by comparison. Looking at other competitors, Dunkin Brands increased EPS by 24%, and Panera Bread reported EPS growth of 16%. Based on these numbers, it’s hard to argue that Green Mountain could perk up many portfolios.

These Old Two Worries Are Back
For several quarters, analysts would suggest that investors should worry because Green Mountain was selling more units, but revenue growth wasn’t keeping pace. This old worry is back, as the company saw volumes increase in both brewer and single-serve packs, yet sales did not keep up.

The first trend that should concern Green Mountain investors is that the company seems to be losing pricing power in brewer sales. The company reported a 6% increase in brewer units on a year-over-year basis. However, this segment actually reported a 4% decrease in sales. Investors might suggest that Green Mountain can afford to lose money on brewers if this drives single-serve sales. However, Green Mountain appears to be losing pricing power in their single-serve packs as well.

The second worrisome trend is that in the single-serve pack business unit volume increased 21%, but sales only increased 18%. The disconnection between unit volume and revenue growth could mean that customers are either choosing cheaper priced K-Cups, or Green Mountain is being forced to cut prices to compete with new private-label competition. In either case, this doesn’t bode well for future sales and earnings.

Reading Between The Lines
A third issue facing Green Mountain is maybe the most disconcerting, as it suggests weaker demand in the future. One way to gauge the strength in demand for a company’s final product is by looking at inventories. In the current quarter, Green Mountain reported raw material and supplies inventory decreased by 34% in coffee, and 15% in packaging. The company’s brewer inventory dropped by 17%, while single-serve packaged inventory actually increased by 34%.

Significantly less raw material and supply inventory could mean the company is forecasting lower volumes and needs less raw materials to meet this expected lower demand. Lower brewer inventory might mean that Green Mountain is having trouble selling the number of brewers they are producing. A 34% increase in finished single-serve packs, could mean the company is having trouble selling its existing K-cup inventory, and is trying to avoid markdowns that would hurt earnings. As you can see, there are potential warning signs flashing bright red across the board.

Overestimating This Company Is Dangerous
Even after the stock’s recovery, the company’s P/E ratio is roughly 24, yet analysts expect over 22% EPS growth in the next few years. On the surface, this would seem to make the stock a relative bargain compared to its peers.

Dunkin Brands sells for over 28 times projected earnings, yet is expected to grow by about 16%. Starbucks is selling for north of 30 times earnings, and is expected to grow earnings by about 20%, and Panera Bread is growing slower but sporting the same P/E ratio as Green Mountain. Based on these numbers alone, you could make the argument that Green Mountain is the best value of the bunch.

However, if the three recent worries from the company’s earnings report continue, analysts might be overestimating the company’s earnings growth. As we have seen in the past, overestimating Green Mountain can lead to disastrous results. The stock has perked up recently, but if the company disappoints investors again, the shares might be tossed out like a bad cup of coffee.

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Chad Henage owns shares of Dunkin' Brands Group . The Motley Fool recommends Green Mountain Coffee Roasters, Panera Bread, and Starbucks. The Motley Fool owns shares of Panera Bread 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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