A Second Look at Teavana

By Matthew Luke - July 17, 2012 | Tickers: PEET, SBUX, TEA | 0 Comments

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As I talked about in my previous article, American drinking habits are changing. US soda consumption is declining, while tea consumption is increasing. In that article, I also gave a few companies that look to profit from this change toward healthier beverage alternatives. Now I would like to focus on my personal favorite from that list of companies: Teavana (NYSE: TEA).

Since Teavana’s initial public offering in July of last year, investors have punished shares of the company. After initially skyrocketing 73% above its IPO price the first day of trading, shares are now trading 30% below that $17 IPO price. At these levels, I think it is time to take a second look at Teavana.

Lofty IPO Valuations

At its day-one all-time high of $29.35, one could certainly argue that shares were overvalued (or at the very least that they were fully valued). A trailing P/E of over 50 is not unheard of for a high-growth stock. Heck, Amazon is currently trading for 180 times earnings. But at the time with European uncertainty, Greece austerity, continued European uncertainty, more Greece austerity and multiple European sovereign debt crises, nobody was interested in paying up for the growth of a new publicly traded company. It did not matter that Teavana received the majority of its revenue from the United States and all of its revenue from North America. Nobody was interested in paying over 50 times trailing earnings. Combine that with the inevitable end of the 180-day IPO lockup period, it shouldn’t be too surprising that Teavana is down so much from its first day of trading.

Market Disconnect

Oh how things can change in one year. What was overvalued is now undervalued by many measures. Teavana currently sports a trailing P/E of 25.73, a forward P/E of 15.75 and a PEG ratio of 0.68. This to me indicates that the market is undervaluing Teavana’s shares. This compares favorably to Starbucks, which Teavana is often likened to by the financial media. This is not a perfect comparison mind you, but it is probably the closest publicly traded company you can compare Teavana to. For good measure, I’ll also throw in Peet's Coffee & Tea for its obvious tea connection.

(Source: Yahoo Finance)

Profitability

Profitability at Teavana is already exceptional for a company so young. As the above chart shows, Teavana has a profit margin of 10.11%. Again with the Starbucks comparisons, you see that Starbucks clocks in at a 10.56% profit margin. Starbucks has one of the best profits margins in the industry. So Teavana falling only 0.45% short of Starbucks is nothing to be ashamed of.

Margin Expansion

What Teavana does have over Starbucks is the possibility to increase its margins even further through the natural maturing of its growing business. Tea is a growing market, particularly Teavana’s segment of premium loose-leaf tea. There are new Teavana customers every day. New customers either from existing stores or though new store openings. And there are certain items these new tea customers need to get started. These new customers will need tea pots, tea cups, measuring utensils, containers and other tea-related merchandise. Tea-related merchandise currently makes up 41% of Teavana’s sales.

Tea-related merchandise make for, however, lower-margin purchases. It is the premium loose-leaf teas themselves that are the higher-margin sources. As the Teavana concept matures, Teavana’s profitability will naturally increase. New customers will turn into long-time repeat customers. These repeat customers will have less of a need to purchase the lower-margin tea-related merchandise (as these customers will have already made their merchandise purchases). As a result, the percentage of sales will change to reflect a higher portion of sales originating from the higher-margin premium loose-leaf teas. And as this happens, Teavana will also be able to dedicate more of its store shelves to the actual tea leaf products, further increasing profitability.

North America Expansion

Teavana’s primary operations are in the United States. As of June, Teavana has 218 company-owned stores and 2 franchise stores in the US. Teavana is now moving to expand its business to the rest of North America. With the completion of their Teaopia acquisition earlier this month, Teavana now has 51 company-owned stores in Canada (up from just 5 Canadian stores before the acquisition). Rounding out the remainder of North America are Teavana’s 16 franchise stores in Mexico.

This expansion in North America looks to continue this year and in future years. In addition to the 46 acquired Teaopia stores, Teavana looks to organically add a total of 60 stores this year, bringing the total store count to over 300 by year’s end. By 2015, Teavana expects to have over 500 stores.

Global Expansion

This expansion is not limited to just North America. Teavana has many near-term goals for global expansion. In the second half of this year, Teavana will have opened its first Middle Eastern store. This will be one of many stores under a franchise partnership for the countries of Bahrain, Kuwait, Saudi Arabia, Qatar, the UAE, Egypt, Lebanon and Jordan.

Also near-term (although with no specific plans made public yet) is expansion into Europe. Given the uncertainty in Europe, I can certainly understand why the company has not released specific plans as of yet. Much, much longer-term are plans for expansion into South America, Asia and Africa. That that will be much later for the company though. North America, the Middle East and eventually Europe are more than enough for the time being. Expansion is great, but overextending in the quest for growth is rarely a good idea -- a lesson the business world learned from Starbucks.

Are shares of Teavana right for your portfolio? That I cannot say. I can tell you that if you have not paid attention to Teavana since its IPO, now might be the time to give it a second look.

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