GMCR a "Buy" Over These 2 Coffee Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the last twelve months, Starbucks (NASDAQ: SBUX) has surged 26.7%. Although the trend has reversed over the past three months, with shares down 5.5%, the company still continues to trade as if a massive growth curve is ahead. It isn't. And we need to stop pretending like it is.
The fact of the matter is that Starbucks has already realized its impressive growth over the past few decades, as it saturated the market on seemingly every street of America. At this point, there is less upside in the stock than what the market currently appreciates. Shares currently trade at a respective 27.7x and 23.2x past and forward earnings. That's simply way too high for a company where there is very little room left to expand.
Analysts forecast 18.5% annual EPS growth over the next five years. Assuming this is accurate, 2016 EPS will come out to $3.56 - around 2x what was generated over the TTM. Now, over the past five years, Starbucks has traded in "no man's land" with a historical average PE multiple of 31.5x. The firm's equity is now more than seven times the book value. Assuming that the company trades at a future multiple of 20x, the future value of the stock would be be $71.20. Discounting backwards by 10% puts the present value at $44.21. This means that Starbucks is currently overvalued at generous multiples and growth forecasts. The firm recently opened its first pop-up store in Japan to generate visibility that will test for future demand. If results are positive, maybe the company can generate strong enough returns to justify the current valuation - but, again, 18% returns on a 20x multiple won't cut it.
Often in value investing, the most attractive investment could be the weakest company. Such is the case with Green Mountain Coffee Roasters (NASDAQ: GMCR) and Starbucks. I actually find the former to be undervalued despite poor operating performance. Over the past twelve months, GMCR has been on a more or less consistent decline, with nearly three-quarters of shareholder value being lost. At this point, the PEG ratio is at 0.61 under EPS annual growth forecasts of 23.5% over the next five years. This make GMCR a highly compelling buying opportunity.
It should be noted that GMCR beat analyst expectations by an average of 24.3% over the past three quarters - two of which beat consensus estimates; the other being "merely" in-line. In fact, over the past five quarters, there has only been one miss, which was insignificant at $0.01 below expectations of EPS of $0.47. What then is the reason for Street pessimism? Well, GMCR has seen negative free cash flow surge from just -$1.8 million in 2Q09 (ttm) to nearly -$100 million in 2Q12, well above the -$74 million 5-year average.
If GMCR is to turn around the business, shareholders can expect some solid returns. The turnaround at Dunkin' Brands (NASDAQ: DNKN) will, ultimately, need to be more dramatic. Since the company IPO'd more than one year ago, the stock has only gone up 4.2% while the NASDAQ has gone up 8.4%. At 20x forward earnings, unlike for GMCR, there will have to be significant growth ahead to even justify the current valuation. Margins may have risen to nearly 80% but debt is still high with a debt-to-equity ratio of nearly 2x. The firm is preparing to increase its scale in India, but interest coverage and quick ratios are weaker than peers. This means that it will be hard to penetrate emerging markets despite the desire to do so. Accordingly, I recommend opting to buy shares in GMCR over Dunkin' and Starbucks.
Interested in Additional Analysis?
With Green Mountain as cheap as it's ever been, many investors are wondering whether this is the end of the former market darling, or the perfect entry point for an enormous rebound. You can find our recommendation for how to play the company in The Motley Fool’s new premium research report. In it you'll find everything you need to know about Green Mountain, including whether it's a buy at today's prices. Click here for instant access.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Starbucks and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters, short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters, and 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.If you have questions about this post or the Fool’s blog network, click here for information.