Shares of coffee giant Green Mountain (GMCR) were slammed on Monday after hedge fund investor David Einhorn said that the stock should be shorted. I respectfully disagree with Mr. Einhorn and others that are against the stock. Here are a few reasons why:
1. Recent Performance: I'm not thrilled with Mr. Einhorn's work this year. He first tried to invest in the New York Mets, but that fell through. Apparently, he was too greedy and was just trying to get control of the team in a few years. Right now, the Mets are losing tons of money and will always be the #2 team in the city. But that was a personal investment. Let's look at some of his fund's holdings as of June 30. I don't give him credit for having Apple (AAPL) as a holding, because it's, well, Apple (and after the earnings report it will be down a bit). Now the S&P 500 is down 9% since the end of the 2nd quarter, so you would expect some holdings to be down. But Einhorn's #4 holding, Sprint (S), is down almost 50% since then. It will be interesting to see if his fund adds more Sprint shares at these lower levels. Despite the heavy probability of the company needing capital and further diluting shares, Mr. Einhorn says he still likes the stock. Another dog is Best Buy (BBY). It's down 20% over that time period, and the fund added to its holdings. Interesting selection considering the lack of potential growth prospects. If you look at the rest of his top ten as of June 30, most of them are down at least single digits since then (along with the market), and about half are down in double digits.
2. Timing: The timing of this might be a little questionable. I would like to know what Mr. Einhorn's position was in Green Mountain stock before this speech. Was he short the stock going in? And what was his basis? He says short a stock at $93 that has spent quite a bit of time the past few months above $95. Shouldn't he have made these comments when the stock was at $115? Since I'm not! an inve stor in the fund, I'm not sure we'll get an answer on this point anytime soon.
3. Competitive Balance in 2012: Mr. Einhorn argues that Green Mountain will be in trouble when certain patents on some of its products start to expire over the next year or so. He argues that other companies, such as Kraft (KFT) may start producing similar K-cup type products. Okay, but how many people are going to switch right away? I'm not a coffee drinker, but I know plenty of people are. And all I hear is that people love the flavors. A lot of businesses use Green Mountain coffee in their workplace, and I don't see them changing that anytime soon. Why get rid of something you know and love just because something new is out?
4. Bad Accounting and GAAP Issues: The company has seemed to have this cloud loom over it for a while, and they have had a restatement or two here or there. But, people were saying this when the stock was at $30 a year ago. It's now above $80 and has been higher. Until actual fraud or other issues come out, I wouldn't take note.
5. Valuation: Well, thanks to Mr. Einhorn, this valuation is even better than it was two days ago! GMCR is currently trading at 31.46 times fiscal 2012 earnings (ending in September). Starbucks (SBUX) is trading at 23.32 times fiscal 2012 earnings. However, Starbucks is expecting 10% revenue growth in fiscal 2012, and GMCR is expecting 61%. Likewise, Starbucks is expecting 20% EPS growth, and GMCR is expecting 58%. Peet's Coffee and Tea (PEET), another competitor of GMCR, is expecting similar revenue and EPS growth to Starbucks, and is trading at a forward P/E about 2 points higher than GMCR (I must note that the fiscal year for PEET ends in December 2012). Now that GMCR has come down a bit after this call yesterday, the GMCR valuation is actually pretty good. I'll pay a little extra for that explosive growth. And if you look at the current price to expected earnings growth over the next 5 years, GMCR is at ! 1.47 whi le Starbucks is at 1.61.
6. GMCR's Financials: I always like to look at some financial data for a company when analyzing it, so let's do that here.
Like many growing companies, the current ratio has come down over the past two years. This is not a surprise. And it's not a concern. Apple's current ratio has come down over the past two years. It's just a matter of math. As long as working capital stays where it is or rises like it has been, I won't be worried. The quick ratio is coming down too, but that's because the company has always kept a low cash balance. As a side note, both the current and quick ratios include cash that is deemed as restricted cash on the balance sheet. As I said before, working capital is strong. The company also paid back a large portion of debt recently and took on some more equity, so the debt (liabilities to assets) ratio has come down in recent quarters. At these levels I'm positive unless it starts rising quickly, and I don't see that happening anytime soon.
| Profitability | 4Q 2009 | 1Q 2010 | 2Q 2010 | 3Q 2010 | 4Q 2010 | 1Q 2011 | 2Q 2011 | 3Q 2011 |
| Gross Margin | 31.66% | 29.15% | 33.44% | 35.23% | 30.41% | 25.11% | 37.50% | 36.82% |
| Operating Marg! in | 11.40% | 6.60% | 12.68% | 12.26% | 11.17% | 4.01% | 18.47% | 16.64% |
| Profit Margin | 6.47% | 3.58% | 7.60% | 5.96% | 7.23% | 0.39% | 10.09% | 7.86% |
| Return on Assets | 2.28% | 1.47% | 2.75% | 1.76% | 4.39% | 0.11% | 2.51% | 2.03% |
| Return on Equity | 4.87% | 2.09% | 3.96% | 2.85% | 8.28% | 0.27% | 6.51% | 3.94% |
It will be interesting to see the company's fiscal 4th quarter numbers when they are released next week. This is usually the company's highest profit margin quarter, and in the last two quarters the year over year numbers have been significantly higher. I expect a continuation this quarter. The company has had two strong quarters recently, and I don't think this was a fluke.
| Activity | 4Q 2009 | 1Q 2010 | 2Q 2010 | 3Q 2010 | 4Q 2010 | !1Q 2011 | 2Q 2011 | 3Q 2011 |
| Receivables Turnover | 2.78 | 3.01 | 2.41 | 2.42 | 2.48 | 2.80 | 2.79 | 3.14 |
| Inventory Turnover | 1.26 | 1.89 | 1.85 | 1.36 | 1.16 | 1.62 | 1.42 | 1.26 |
| Asset Turnover | 0.35 | 0.41 | 0.36 | 0.30 | 0.29 | 0.29 | 0.25 | 0.26 |
The receivables and inventory turnovers have maintained their levels and have shown improvement at times. These numbers are not signs of a struggling company. The asset turnover has come down, but that's only because assets have increased about 3 times over the past year and a half while revenues have increased about 2 to 2.5 times. I'm not worried unless this number trends significantly lower.
My Overall Opinion: I respect Mr. Einhorn's opinion as well as those out there that are negative on the stock, but I disagree with their view. Those that have been negative on this stock have watched it continuously rise for the past year from $30 to $80, and even over $100 at times. Now, I will admit, the stock may have been a bit overvalued recently at $115, but now it is at $82. Mr. Einhorn's comments took $10 off the stock in one day. Obviously, he didn't get to the position he is in now by being wrong a lot, but some of his holdings have not done well (Sprint, Best Buy). I bel! ieve tha t this stock is still a buy, however I might wait to pull the trigger as I believe the market will take some profits here soon. I think that Mr. Einhorn is a very bright man and a great investor, but on Green Mountain Coffee Roasters, I respectfully disagree.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.
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