Farmer Brothers: A Very Strong Brew

| About: Farmer Brothers (FARM)

To say Farmer Brothers (NASDAQ:FARM) has been strong lately is an understatement, it has been darn right "Herculean," doubling in six months, equating to a very lofty 200% APR. Despite those gains, there is still time to ride the momentum train, as each time it begins to sell off, new buyers quickly move in. This action creates a pattern of higher highs and higher lows - desirable technical traits. A recent bout of profit taking has sliced 7% from the stock's recent highs, creating another re-entry point, for those who still want to open a position without chasing it to new heigh

Do you recall Krispy Kreme's (KKD) epic comeback from the ashes? Just four short years ago, its shares were crossing at $1, now they bring $11. I am not saying FARM will see its shares experience the same "ten bagger" phenomenon as my favorite donut maker did, but a "four to five bagger" is certainly plausible, translating into a $20 share price.

Second quarter estimates: Earnings are expected to be released the first week of February and FARM is forecasted to earn 24 cents on sales of $143 million. That is a significant difference compared to a 6 cent loss on sales of $123 million it generated last year. This forecast could be considered conservative when considering the new commerce the coffee roaster has recently obtained. In fact, this investor anticipates a far better showing, earning 26 cents on sales of $147 million due to lower costs, recently landed business and further softness in commodity expenditures.

Private labeling: The company derives 25% of its revenues from this segment. Although it is less profitable, it also carries reduced risk, as most of this business is predicated on a cost + margin basis. Pricing is based on the price of raw coffee plus a fixed markup. Besides its Target (NYSE:TGT) business under the label Archer Farms, Farmer's has landed contracts in the large retail area with drug store mammoth Walgreen's (WAG) and grocery retailers Sweetbay, Hannaford and Food Lion (all members of the Delahaize Group).

Recent highlights: It is notable to mention the company is also active in the Convenience store space. FARM recently won vendor of the year from Sheetz Inc., the operator of 400 convenience store locations. In the restaurant area, accolades were also noted from Einstein Noah Restaurant Group (NASDAQ:BAGL), nailing their supplier of the year award. FARM recently increased their marketing and sales personnel by an additional 30 personnel, all focusing on national sales accounts.

Single serve segment: Although FARM will not be manufacturing k-cups directly, they have landed a contract to supply the coffee for TreeHouse Food's (NYSE:THS) Sturm division's k-cup manufacturing efforts. This business is wide open, now that Green Mountain Coffee Roasters' (NASDAQ:GMCR) patents have begun to expire. The downside for the pod business is its high cost K-cup delivery method, which runs four times the cost of traditional brewing. It is inevitable some consumers will begin scaling back from this very expensive approach to convenience.

New McDonald's supplier: There has been plenty of speculation that FARM had gained a foothold as a McDonald's (NYSE:MCD) supplier. The speculation finally ended at the Annual Shareholder's Meeting last month. CEO Michael Keown confirmed FARM commenced shipping product to the famed burger chain in November. CEO Keown explained that other than the confirmation of a business relationship, he was unable to provide any color on the Golden Arches partnership. My gut feel is that FARM is gearing up to help support MCD's quest to begin selling bagged coffee in US supermarkets (it already sells bagged coffee in Canada).

Wall Street Analysts take notice: The shares have more than doubled in the last six months and Wall Street is noticing. Roth Capital Partners increased its latest price target from $14 to $17 while Zack's has designated its highest rating (strong buy #1 rank). Singular Research has initiated coverage with a $15 target price. On the flip side, the farther the stock climbs, the higher its earnings expectations become. Wall Street is a constant pendulum, swinging too far to the right when things are good, and way too far to the left when operations are troubling. As far as FARM is concerned, its price pendulum definitely contains more room available to the right side. After all, it is still in the infancy of its turnaround process.

Merger and Acquisition Activity: The coffee segment has been under consolidation and appears to be ripe for more, especially now that green coffee prices have fallen. Both Peets and Caribou (NASDAQ:CBOU) were recently acquired by the same suitor at a 30% premium. Coca-Cola (NYSE:KO) has just acquired the Georgia Coffee Company while Green Mountain Coffee Roasters purchased Dietrich and Tully's.

FARM could easily fetch a 30% premium if it too was targeted. The buyers are out there, the question is will FARM's majority shareholder be open to a such a transaction? If it walks and talks like a takeover candidate, it probably is one (everything is for sale at the right price). The company eerily resembles the last coffee company I was active in (Chock Full of Nuts), just before it was acquired by Sara Lee.

Conclusion: I usually preach the method of buying low and selling high. Since FARM has already doubled, it is difficult to lump it in the "low" category. In FARM's case, the advice of the day is to buy high and sell higher. After all, there is a cost to having momentum on your side.

Disclosure: I am long FARM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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