"More Than Just a Dead Cat Bounce"...
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Editor's Note: Greenlight Capital has not disclosed a short position in Herbalife, this version has been corrected.
Value investor David Einhorn has been successful targeting entrenched management before and shaking up the status quo to unlock value. However, of late, he has targeted the wrong companies--those that have succeeded despite challenging macro conditions. His bearish theses have sent crashed company valuations from sometimes just speculation alone. While these attacks have netted Einhorn millions, it has opened up the opportunity for you to create wealth through just the opposite approach. Below, I review two companies that he wrongly targeted.
Green Mountain Coffee Roaster (NASDAQ: GMCR): A Case Study For Herbalife...
This well known Einhorn short fell from a high of $110 to a local low of around $17.50. It has since recovered to $41.34 and rallied 141.6% from the 52-week low. In my view, it remains incredibly undervalued. First, the company is cheap probably by anyone's standards on a multiples basis. It trades at a PEG ratio below 1, which indicates that future growth has not been fully factored into the stock price. Second, it has delivered 75.4% annual EPS growth over the past 5 years. By contrast, competitor Starbucks (NASDAQ: SBUX), which trades at 30x past earnings, has only grown EPS by a rate of 5.4% during the same time. While the analysts continue to expect GMCR to outperform by around 200 bps more per year, this is not nearly optimistic for several reasons.
First, Starbucks has made a name for itself by saturating the market. The question that naturally follows but seems to not be asked is: how much penetration potential is left? Whereas Starbucks has few growth opportunities, as I see it, in the specialty coffee market, it has plenty of headwinds. The entrance of McDonald's in the grocery coffee market will pose a secular margin pressure on Starbucks in its attempt to stay, or even elevate, demand for higher-price coffee. GMCR, however, is just getting started in penetrating new markets. I thus strongly encourage buying GMCR over Starbucks. It should not be surprising then that GMCR has outperformed expectations by a higher average amount (36.3% vs. 2.4%) compared to its competitor.
Going forward, I anticipate strong returns for GMCR. The company recently made a deal with Costco that will help the company increase leverage towards a recovering economy. In the deal, Costco will carry single-serve coffee pods for the Keurig brewing system with a goal to sell the items by December. Shorts are starting to cover while people are becoming more encouraged about the single-serve market allowing for multiple competitors.
Herbalife (NYSE: HLF): More Than a Dead Cat Bounce
During the company's earnings call, David Einhorn suggested that the company could be running an illegal pyramid scheme. While the company has recovered from the bear attack, the effort was renewed by fellow activist investor Bill Ackman who explicitly called the company a pyramid scheme. Shares fell 54% from the 52-week low because of Ackman's claims. While they have since soared 35.9% from the 52-week low, I still believe the company is positioned more towards upside than downside from here for several reasons.
First, just purely on valuation. At a multiple of 15x, this translates to a future stock value of $66. Discounting backwards by 10% yields a present value of around $41 - 25% above the prevailing price. Free cash flow yield is also strong at 8.5% and rising. The PEG ratio stands at just 0.54--GMCR soared off of a multiple that was much higher…
Which brings me to my second point: the company is likely to use much of its free cash flow to aggressively repurchase shares. This is the best way that management could counter Ackman's thesis. It would essentially communicate to the market that the company has real cash, and it believes its stock is undervalued from a market behavioral anomaly.
Third, in regard to the pyramid scheme allegation--Lieberman Research has shown that one-twentieth of US households have consumed a Herbalife product in the last 3 months, and that 90% of those individuals came outside of the distribution network. In order for a company to be getting most of its sales outside the distribution network, it requires, well, real products. Herbalife has also succeeded for some time in China where direct selling is expressly forbidden. Clearly, Herbalife's products have value, and this is going to be communicated to investors in the company's special analyst call.
Fortunately, the MLM seller has also consistently outperformed expectations over the last 5 quarters by an average beat of 11.7%. It should be noted how far off the company is from analyst price targets. While Argus recently downgraded the stock from a "buy" to a "hold", Longbow upgraded to a "buy" with a $130 price target. You read that correctly - a price target around quadruple the current trading price. If the company's strong growth curve and low multiples weren't enough to compel an investment then this should be.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Starbucks 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!