Investors in Green Mountain Coffee Roasters Inc. (GMCR) are waking up to an unfamiliar stock price today.  For the second time in 2 years, the stock has split – this time investors are receiving 3 shares for every 2 shares previously owned.  The move causes no economic change for shareholders, but does potentially make the stock more attractive to individual investors who may shy away from buying a stock priced at more than $90 per share.

GMCR has seen its stock price appreciate more than 300% over the last year as investors cheer the robust growth in the midst of one of the deepest recessions in history.  The growth in revenues and earnings is certainly impressive as consumer spending drops, but not nearly as impressive as the appreciation in the stock price.  Based on expectations for 2009, the stock is now valued at more than 60 times earnings – quite a hefty multiple for a consumer driven niche coffee company.

Now I understand that Green Mountain currently tops the Investor’s Business Daily 100 list and has been a main staple in this elite group for several months running.  I find this list to be very helpful in finding growth companies with excellent track records and more than once I have found opportunities that have offered chances to double or triple my investment.  However, the list is also an excellent source for finding potential short opportunities because of the fact that optimism can often drive stock prices to unsustainable levels.

The current optimism in Green Mountain stems from the many distribution deals the company has signed over the last few months.  Most importantly was an agreement with Wal-Mart which puts the company’s products in more than 3,000 locations – a move which is certain to drive sales in coming quarters.  On a smaller scale, the company has also signed agreements with Cuisinart and Conair.  Coffee is distributed using the Green Mountain brand as well as under the Newmans Own and Tully’s brands.

Analysts are currently projecting earnings for 2009 to reach $1.52 per share (pre-split) plus an additional 40% in 2010 to a level of $2.13 per share.  If you take the stock split into account, the expectations move to $1.01 in 2009 and $1.42 in 2010.  This type of growth rate is very impressive and partially justifies the high price for the stock.  Despite the fact that this coffee trend may be a “fad” approach, it is difficult to argue with the success in terms of both sales and earnings.

However, looking at the balance sheet, Green Mountain has accumulated a significant amount of debt in order to finance its growth.  Currently long-term debt sits at $118.7 million after the acquisition of Tully’s brand.  The company has also increased its guidance for capital expenditures in the coming year which will likely lead to higher debt levels. The majority of the company’s current assets are in the form of accounts receivable and inventories with very little in cash.

Now it is unlikely that debt will be a significant issue for the company due to the robust sales levels and positive cash flow.  But the leverage adds a degree of risk which could cause investors concern if we enter another stretch where liquidity is an issue.

Over the next few quarters I expect analysts to begin to develop longer-term forecasts, guiding investors to view the 5 to 7 year growth rate near 25%.  After all, it’s going to be tough to find an encore to the Wal-Mart deal.  Looking at the stock price, I would think investors would eventually look at a 25 multiple as being reasonable – and if applied to the 2010 estimate of $1.42 per share, this would yield a stock prece near $35.50.  At this point investors have raised the price on nothing but good news and it will be interesting to see how they react to anything that could be considered less than optimal.

Shorting runaway stocks can be dangerous and anyone who shorted outright when ZachStocks offered a cautionary note back in April is definitely under water right now.  One way to benefit from a potential decline would be to buy puts on the stock.  While these contracts are a bit expensive due to the volatility of the stock, this type of approach allows a trader to cap his risk while still participating in the downside.  If GMCR begins to drop it could move very quickly because of the fickle nature of the current investor base.  For those long, I would urge caution and recommend at least hedging the position by selling calls or buying protective puts.

FD: Author has a short position in GMCR

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