Green Mountain Coffee Roasters (GMCR) is down sharply this morning after announcing earnings last night. While the revenue and profit numbers for the fourth quarter (the company operates with a September year end) showed considerable growth, the stock (which is featured in the Retail Fail quarterly sector report) had been priced for perfection and it appears that investors now have some concern with the rosy outlook.
For the quarter, Green Mountain reported earnings per share of $0.34 which beat the 33 cent consensus estimate and represented an increase of 89% above last year’s level. Revenue was $222.2 million which also beat estimates and represents a 65% increase over last year. The third quarter was certainly a victory for the company, but looking forward the picture is a bit less optimistic.
Management issued its outlook for the first quarter which includes sales growth of 61 to 66% ($317 million to $327 million) and earnings growth of 11 to 15 cents per share. Since analysts had been expecting first quarter earnings to approach 19 cents per share, this is obviously a disappointment. While the sales growth guidance is relatively in line with the market’s perception, operating margins are expected to be between 3.8% and 4.3% which is well below the 11.4% operating margin in the fourth quarter.
There may be a reasonable explanation for such a steep drop in operating margins. Green Mountain’s business model is to sell its coffee machines at nearly break even in order to get customers hooked on its brand. Then once the machine is installed, GMCR makes a much higher profit margin on the K-cup coffee servings. The strategy is similar to HP who invented the model of selling printers for a loss and then making a killing by supplying the ink cartridges.
Overall, the growth story for Green Mountain remains intact and as a stand alone business, they are very attractive. The distribution deal with Wal-Mart (WMT) continues to drive sales and will likely be a stable source of revenue for the foreseeable future. Management has a legitimate reason to be proud of their success.
GMCR is executing on its plans and running on all cylinders as the innovative and proprietary Keurig Single-Cup Brewing System continues to transform how consumers in North America prepare and enjoy their beverages. The resulting demand for K-Cups is fueling our growth. This past quarter, Keurig realized the highest ever quarterly year-over-year increase in K-Cup shipments since becoming part of GMCR in the third fiscal quarter of 2006. ~Lawrence J. Blanford, CEO
From an investment standpoint, however, I simply cannot justify the price that GMCR is trading at. Current investors are buying the growth story with very little regard for the actual fundamental valuation of the company. Using Wednesday’s closing stock price, and the high end of management’s updated guidance for 2010, investors are paying 41 dollars for every dollar the company is expected to earn. That’s an exorbitant multiple and as we are seeing this morning, carries quite a bit of risk.
It is always difficult to anticipate the short-term price movement directly after the earnings announcement. Obviously investors are frustrated with the first quarter guidance and have sent the stock lower to begin the day. But it wouldn’t surprise me to see a rally over the next few days as bullish investors take advantage of a low price and accumulate more shares.
But over the next several weeks, I expect this news to sink in and cause more suspicion in the stock. It is quite possible that analysts could assign a multiple of 35 or 30 or even 25 times projected earnings. This would occur if the long-term growth rate were called into question. After all, it’s going to be hard for the company to find a repeat event for it’s Wal-Mart contract win from this year. At a still-aggressive multiple of 30 times 2010 expectations, the stock would trade in the mid 50’s which represents quite a decline from the current levels.
Aggressive traders could consider taking a short position in this name, although tight risk control should be used. If the stock rebounds and closes above $76, I would become concerned and step away until a better opportunity arises. Option premiums are very high which may prevent traders from buying puts outright, but may set up a better opportunity. Consider selling the stock short and then selling the December or January $65 or $70 puts. This would allow you to collect some attractive premiums which will offset losses if the stock runs higher. If the stock continues to trade lower, you may sacrifice some of your gains, but your rate of return will still be very attractive.
FD: Author does not have a position in GMCR
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