Party Like It's 1773

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Tea has been an integral part of American society since colonial times, as witnessed by the Boston Tea Party’s role in helping to launch the Revolutionary War.  According to the Tea Association of the USA, an industry trade group, U.S. wholesale sales of tea in 2011 were $8.2 billion, the 19th consecutive year of industry growth.  The sales growth was again concentrated in the ready-to-drink segment, which offers consumers convenience as well as the positive health benefits of tea compared to carbonated alternatives.  Large food companies have been targeting the tea market for years through acquisitions of small, innovative product marketers, including Pepsico’s purchase of SoBe in 2000 and Coca-Cola’s purchase of Honest Tea in 2011. 

On Nov. 14, Starbucks made their own investment in the tea business by agreeing to purchase Teavana (NYSE: TEA) for $15.50 per share in cash, a 53% premium to the prevailing stock price.  The offer values the company at 3.6 times FY 2011 sales and 34.0 times FY 2011 net income, and the transaction is a big bet on Starbuck’s ability to leverage its existing distribution channels to continue building the brand.

What’s the Value?

Teavana is a specialty retailer offering 100 varieties of loose leaf teas, tea products, and related merchandise through approximately 300 stores in the U.S. and Canada.  Teavana’s self-described mission is to provide a “Heaven of Tea” experience for its customers through superior products and knowledgeable employees.  Over the past four fiscal years, the company grew its sales by 256.1% by greatly expanding its store base, as well as increasing the productivity and customer transaction sizes in its existing stores.  In FY 2011, Teavana reported sales and net income of $168.1 million and $17.8 million, increases of 34.8% and 48.0%, respectively, over the prior year period.  The company’s gross and operating margins reached the highest levels of the last five years as it achieved growth in same store sales of 8.6% and benefited from a larger, more diversified store base. 

In 2012, the company has continued to pursue of its goal of operating 500 stores by 2015.  As of September, the company had opened 38 new stores and added 46 additional stores through the June acquisition of the Teaopia chain of stores.  For the nine month period ended Sept. 30, Teavana reported sales and adjusted net income of $87.4 million and $4.8 million, increases of 31.9% and 9.1%, respectively, over the prior year period.  The company benefited from more productive stores, with same stores sales up 2.5%, but operating margins declined as the company continued to integrate the less-profitable Teaopia stores.  For the FY 2012 period, Teavana expects net income to be between $20.8 million and $21.8 million, an increase of 19.7% over the prior year.  Starbucks' offer values the company at roughly 28 times FY 2012 net income, a rich premium and a strong belief in the brand’s growth prospects.

The Next Opportunity

Now that Teavana is being acquired, where should an investor go to find an investment in the tea industry?  Since most tea marketers are privately held or are part of larger corporations, a direct investment in the sector is unlikely.  Instead, investors should look at those food service companies that have significant, direct exposure to the coffee and tea business.  The company best positioned for future growth in this area is Starbucks (NASDAQ: SBUX).  After some missteps that led to the return of CEO Howard Schultz, Starbucks is once again performing well and operating efficiently.  For FY 2012, the company reported revenues and net income of $13.3 billion and $1.4 billion, increases of 13.7% and 11.1%, respectively, over the prior year period.  Starbucks continued to grow its store base in 2012, with 1,063 new stores globally, and it achieved growth in global same store sales of 7%.  The company continued to focus on the Asia Pacific region, which accounted for 42% of the new stores.  This region consists of nations with large tea drinking populations, and the Teavana acquisition should be a good complement to Starbucks’ Tazo brand as the company tries to continue to win new customers.

Alternatively, investors should look at Green Mountain Coffee Roasters (NASDAQ: GMCR), a leader in the wholesale coffee business and owner of the Keurig brewing system, the best selling single-serve coffee maker.  After exponential growth during the 2007-2011 fiscal year period, the company has been pressured lately by slowing growth, questions about its accounting practices, and price competition in the single-serve coffee market.  During the first nine months of FY 2012, the company reported sales and net income of $2.9 billion and $270.7 million, increases of 52.6% and 118.1%, respectively, over the prior year period.  Gross margins have been negatively affected this year by the costs of unused manufacturing capacity as sales growth has declined versus previous years.  However, Green Mountain currently expects FY 2013 adjusted EPS of $2.55 to $2.65, a reasonable 11 P/E multiple to recent stock price levels. In addition, they have licensing relationships with the major tea manufacturers and sales of their brewers should benefit as more customers use their Keurig system for their daily cup of tea.

rghanley has no positions in the stocks mentioned above. The Motley Fool owns shares of Starbucks and Teavana Holdings and has the following options: short JAN 2013 $47.00 puts on 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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