Three months ago, Green Mountain Coffee Roasters (GMCR) earned 64 cents a share, handily beating the Street's estimate of 48 cents a share. The stock gained 27% the next day. But about one year ago today, the company missed expectations, and the stock fell a whopping 30% on the following day.
The company reports earnings after the close on Wednesday, February 6th. Which of the above two scenarios is likely to repeat? The market is preparing for the fireworks. Implied volatility of the weekly options, which expire two days after the announcement, has soared to 164, about five times what it is in "normal" times. The options are predicting about an $8 price change on a $46 stock.
This is a truly exciting time for people who follow GMCR. Three months ago, I wrote a Seeking Alpha article in advance of the earnings announcement -- "A Dynamite Options Strategy To Play The Green Mountain Coffee Roasters Earnings Announcement" -- in which I warned about a possible short squeeze on the 50 million shares sold short (about 34% of the total outstanding shares). I got a chuckle out of the comments made -- either people loved or hated the company. No one seemed to have a lukewarm or neutral feeling. Most seemed to hate it.
A well-researched recent Seeking Alpha article described the meteoric history of GMCR in wonderful detail -- "Green Mountain Coffee Roasters 3.0". This article should be required reading for anyone interested in taking a position in this company (short or long). While it does a great job of chronicling the basic business of the company (and its future potential), it doesn't take a close look at the current stock price and conclude whether it is fairly valued according to his analysis.
Is GMCR Fairly Valued?
While there are a gazillion ways to value a company, I like to keep it simple and compare the company's P/E ratio and the expected growth rate. If the P/E is less than the expected growth rate, I assume that it is fairly valued. GMCR's latest P/E is 18.7 trailing and about 15 forward, and sports an average 5-year sales growth rate of 63.2% and an average 5-year EPS growth rate of 81%. Last quarter, revenues grew 33% over the prior quarter (or about 30.6% adjusted for an extra week in the quarter). Future growth rates will surely be lower, but will probably be higher than the company guidance of about 15% (see my comments on guidance, which follow below).
In short, in my opinion, the company's current stock price is a fair value given all the information that is publicly available at this time.
When many writers cite GMCR's P/E, they invariably compare it to Starbucks (SBUX). I think such comparisons are specious. Yes, both companies sell coffee. That's about it. Virtually nothing else about the two companies is close to being similar. For example, SBUX seems to be becoming a play on China, and as far as I know, GMCR is not even in that country, at least not yet.
Why Has The Stock Gone Up 62% In The Last Three Months?
The closing price before that last earnings announcement was $28.95, and the next day, it closed at $36.85, up 27%. Three months later, it is trading at $46.92, or 62% above the pre-earnings announcement price. The initial price was likely due to the positive results, which beat expectations, but guidance seemed to be a little on the conservative side.
It seems to me that much of the recent run-up in the price can be attributed to short-sellers covering their sales (i.e., buying them back) and the company continuing with its share-repurchase program.
Let's check out the short sales situation:
Over the past two months, about 20 million shares of GMCR stock have been bought to cover short positions. If the average price during this time was about $40, that means that $800 million was spent to repurchase these shares. That is a huge amount, far greater than what I figure the company spent in buying back shares.
During the Q4 2012 earnings release, GMCR reported that it had used $175 million of the Board-authorized $500 million toward the repurchase of shares at an average price of $23.72 per share. Wow, what a good move! The company could sell those shares at double that amount at today's stock price.
There seems to be some indications that a great many more shares have been repurchased at this time. At the same Q4 2012 earnings release, GMCR reported $76.7 million in free cash flow for the year, and forecast free cash flow in a range of $100 million to $150 million for fiscal 2013. Another quarter has elapsed, and presumably, about $25 or $35 million in cash has been accumulated.
Just prior to the last earnings announcement, when I wrote "A Dynamite Options Strategy To Play The Green Mountain Coffee Roasters Earnings Announcement" (linked above), the company had about $130 million in cash, and today, the latest numbers from Yahoo Finance show that it only has $58 million. Meanwhile, its operations have presumably generated at least $25 million in positive cash flow. If it spent all this cash to repurchase shares, it would only add up to about $87 million (unless GMCR borrowed more). And surely, considerable sums were required to ramp up the new facilities and expand operations in Europe, as its plans seem to be.
Bottom line, it seems to me that the company probably spent a considerable amount on buying back shares, but not nearly the full $325 million remaining in the amount that was authorized. If this is true, there is a lot more buying planned in the future, buying that can only drive the stock price higher.
Why Did GMCR Miss So Badly One Year Ago?
I think this is the most interesting question of all. This earnings miss was responsible for much of the widespread negativity on the company, and I think there is a logical explanation for the big miss.
Almost exactly one year ago, on February 16, 2012, CNN Money reported that Green Mountain Coffee Roasters shares plunged more than 30% on Thursday, a day after the company reported its first sales miss in two years. Looking back a year later, I think it is significant that the company had a long history of providing guidance that was well below reported earnings.
This unusual miss came weeks after the commencement of an SEC inquiry and stockholder suit brought against the company over its accounting practices.
When the SEC has suddenly appeared on your doorstep, those desires would understandably quickly change to whatever it would take to make the SEC go away. One way would be to use the most conservative methods available, even if they might result in a rare earnings and sales guidance miss. My guess is that this is exactly what GMCR did.
The logical conclusion must be that the company decided to issue results that were as conservative as possible to head off a possible SEC action (the shareholder suit was dropped quickly after the next quarterly earnings announcement).
Anyone who understands how financial statements are created knows that there are many ways to take the same numbers and come up with a multitude of different results to report. Back when I was a business school professor, I used a simple lemonade stand example with only 8 transactions and showed how a dozen different profit numbers could be legally reported, depending on what assumptions you chose to use (of course, you would have to use accrual accounting rather than cash accounting, as most public companies do). A large pubic company has infinitely more opportunities than a lemonade stand to tailor reported numbers to its current desires.
The SEC has been looking into GMCR's accounting practices for over two years without doing anything about it. Surely, it wouldn't have taken them this long to identify actionable wrong-doing. Yet the threat of an SEC suit has been a persistent cloud over GMCR (and probably the last hope of the short-sellers).
I live in Vermont, and have had a long-standing interest in GMCR. I used to play tennis every week with Bob Stiller, its founder, but he never divulged a smidgen of inside information. At a birthday party for the president of a local college (last year, Bob Stiller donated $13 million to this college and had a business school named after him), I ran into an old friend who had built a 500,000 square foot new facility for GMCR in Essex ("I think it's the largest building in Vermont under one roof," he said). Yet, as far as I could tell, this huge economic development in our little state was never the subject of any publicity. Before construction could start, a permit needed to be obtained, and that made the newspapers, but nothing (as far as I could see, and I read the biggest newspaper in the state every day) was ever written about this major expansion.
GMCR did not build this facility with its own money, but rather, leased it. That might explain some of the reason that it announced a cut-back in capital expenditures (and maybe to preserve some cash to complete its purchase of $500 million of company shares).
Another expansion, in Virginia, was publicized. Less than two months ago, the company announced that it will open a new manufacturing and distribution facility in Isle of Wight County, VA. The company agreed to purchase a 330,000-square-foot building on 64 acres for $15 million, with plans to invest up to $180 million over the first five years of operation and add up to 800 new workers.
Surely, the company is not adding all this new space in a vacuum. It knows far better than any of us how many Keurig cups it is selling. That number may be quite a bit higher than most of us suspect.
If analysts' opinions can be counted for anything, two of them have upgraded the stock from "hold" to "strong buy" over the past two months (according to Yahoo Finance). One analyst has maintained his "sell" rating, probably in hopes that the SEC inquiry will turn into an action.
Bottom line summary of the reasons I believe the stock will head higher next week:
- Company guidance is extremely conservative because of the SEC and shareholder suits, and actual results may very well top guidance by a large margin.
- The company has recently made two large real estate moves for roasting and packaging to keep up with K-cup demand.
- There are still 30 million (vs. 50 million a quarter ago) shares sold short, which will inevitably be bought back if the company continues to grow (and the SEC doesn't bring an action).
- The company has not nearly completed the repurchasing of $375 million of its authorized $500 million buy-back.
With these thoughts in mind (and because I am an options guy at heart), I plan to buy June-13 40 calls and sell Feb2-13 47 calls expiring on Friday, February 8th to take advantage of the current escalated option prices. This spread can be bought for slightly less than the intrinsic value of the June options if the stock price remains unchanged, and there are five extra months of remaining life over which additional premium might be collected by selling new weekly or monthly calls.
I like the June series because if for some reason I am wrong and the stock falls, I will have another pre-announcement opportunity to sell an at-the-money weekly call in April for about $4 (more than half what I bought the original diagonal spread for), as well as several other chances to sell weekly or monthly calls against those June 40 calls. I estimate that if the stock remains flat or goes up moderately, these positions should make about 30%, and the stock could fall about 5% before a loss would result for the week (if the positions were closed out at the end of the day on Friday).
Another, more aggressive, way to play the announcement is to sell Feb2-13 47 puts and buy Feb2-13 42 puts, collecting about $200 per spread (and risking $300, the amount of the maintenance requirement). If GMCR remains above $47 for two days, both puts would expire worthless, and you would make about 65% on your amount at risk. Of course, you stand to lose with this spread if the stock falls over $2.
I also intend to buy some extra calls, something I rarely do because I am basically a premium seller rather than call buyer under almost all circumstances, especially when option prices are as high as they are this week. But right now, I think GMCR is headed higher, maybe much higher.