Green Mountain Coffee (GMCR) is set to report earnings after the close Tuesday, and its investors are hoping for good news after a disappointing run. For those who haven't been following, Green Mountain peaked at $115.98 in September 2011, and began to decline rapidly shortly thereafter, plummeting to a near-term low of $34.06 only six weeks later. A few bad quarters and patent expirations later, and GMCR has traded as low as $17.11 before its recent rebound to the $28 range.
One of the major concerns in the past few months is the expiration of the company's "K-cup" patents, which could open up the door for rivals like Starbucks (SBUX) to capture market share. Kraft's (KRFT) Maxwell House, for example, has already produced K-cup pods from which GMCR will receive no money. Green Mountain itself has cautioned investors not to expect the incredible growth of the past few years to continue -- another negative catalyst for the share price.
So, what is the market looking for, and how should you play it?
Most obviously, the company needs to meet or exceed earnings expectations. Analysts expect GMCR to post a profit of $0.48 a share. The company issued guidance of 45-50 cents a share, and has said net sales would increase year over year by 25-30%. So, investors are looking for earnings on the upper end of that. In most investors' minds, $0.49 or higher per share would be a very good sign.
Next on investors' radar is the recent appointment of new CEO Brian Kelley, a former Coca Cola (KO) executive. Although he doesn't officially start work until next week, investors would like to hear a bit about his plans going forward. If he does not express his vision for the company, investors may view this as a negative.
Another very important piece of information will be the recent Keurig sales numbers. Some investors were concerned about the massive rebates being offered during the end of the last quarter -- up to $50, depending on the model. Investors will be keeping a particular eye on the Vue brewer, which was launched in response to the K-cup patent expiration and costs $230. On the other hand, Starbucks' competing machine, the Verismo, is $199 and makes espresso as well as coffee. Naturally, investors are worried about Green Mountain being able to sell the Vue in any profitable numbers.
Last but not least, the recent rally in GMCR is currently unjustified. Green Mountain is more than 60% above its July low as of this writing, and there really hasn't been much news to catalyze this move. Even though it is a "cheaper" stock than Starbucks, trading at less than 13 times TTM earnings, as opposed to over 28 times earnings for Starbucks, the market needs to see that GMCR can continue to grow sales after the patent expirations.
In conclusion, in order for Green Mountain's rally to continue, the company needs to say all of the right things when it reports tomorrow. Even a minor slip-up will result in a serious pullback in the recent gains. I don't see the company issuing a perfect report, or even close to it, so I'm bearish on the announcement tomorrow.
I'm playing GMCR with a put spread, using the December options, since after a bad quarter, GMCR tends to move steadily to the downside over a period of a few weeks. I'm a buyer of the $30 puts for $4.20 and a seller of the $28 puts for $3.10, for a net debit of $1.10. Maximum profit of $0.90 (or 81.8%) is achieved if GMCR is below $28 at the December expiration, and breakeven price is $28.90, meaning this trade makes money as long as the stock doesn't go up. I believe the risk/reward ratio on this trade is justified, given both GMCR's recent run, as well as the general feeling in the market as the fiscal cliff approaches. However, more conservative investors may want to simply short the stock, or play a more conservative in-the-money put spread such as $35-32, which costs about $2.25, and has a maximum (but much more likely) profit of 33.3%, as long as the stock stays under $32. Either way, the downside potential cannot be ignored, and a short position is warranted.