Green Mountain Coffee Roasters (GMCR) announced earnings last night, which beat expectations by a fair amount -- and yet the stock fell by about 9% in early after-hours trading. This caused great consternation and questions from many followers of the company's already roller-coaster recent life. What the heck is going on here? Even Jim Cramer can't understand it.
Several Seeking Alpha articles have discussed the latest earnings announcement and conference call implications. I would like to comment on some aspects of the situation, which were not covered in these articles (or were insufficiently discussed, in my opinion).
Here is the essential paragraph from the "Green Mountain Coffee Roasters' CEO Discusses F1Q 2013 Results - Earnings Call Transcript" -- "On a non-GAAP basis, a measure that we feel best reflects the underlying performance and health of the business, we delivered earnings per share of $0.76, an increase of 27% year over year. We also generated $254 million in free cash flow, driven by a 16% lift in revenue. In addition, our results included a 25% improvement in gross profit, and a 23% increase in non-GAAP operating income."
My first thought on reading these words was "how comfortable do you suppose those folks who have sold 31 million shares short (Nasdaq's latest number) feel right now?" I would guess they are not comfortable at all. At least the stock didn't soar 27% in a single day like it did after the last announcement. But how long can they hang on? Some are grasping at straws for reasons to stay short -- "Green Mountain: Too Far, Too Fast". But those reasons are fast becoming a little weak compared to guidance of 15%-20% earnings growth going forward (from new management, which has so far under-promised and over-delivered). I would be very scared being short this stock going forward. In fact, I would cover my shares now while the stock is still at this low level.
Some Stock Price Behavior Due to Options
There are some options-related explanations to the price behavior of GMCR this week. Most significantly, a great many people bought the stock early in the week and sold slightly in-the-money calls against the stock. Their strategy was to collect the extremely high call premium that was available because of the pre-announcement implied volatility escalation, and let their stock be called away from them on Friday. That is exactly what George Acs suggested that he was planning to do (if you know his basic approach and can read between the lines) -- "Rolling With The Punches", and many of my subscribers wrote to me telling me that was their plan. It is a fairly safe and almost always profitable play.
This kind of buy-write option play is bullish because the delta of the long stock is (of course) 100, while the delta of the short call is 70-90, depending on how far deep in the money it was. GMCR started out the week at $46.50, and ended at $48.94 at the close on Wednesday just before the announcement. That 5.2% run-up could have been entirely caused by buy-writers (maybe joined by some short-coverers who became a little anxious before the announcement).
At Friday's expiration, the stock will be called away from those buyers (assuming the calls they sold were in the money). That will be a bearish move for the stock as all those shares are sold. The market makers who need to balance out their risk will know this is coming, and will sell shares in advance (possibly explaining some of the initial weakness of the stock immediately after the announcement).
Another options-related move that might influence the stock price involves those 31 million short stock sales. If I were one of those people, especially in light of how well the company seems to be doing these days, I would hedge my bet by selling some puts (and collecting premium like the buy-write guys do). When such put-selling takes place, the other side is usually done by market makers who buy those puts. This makes them bearish, and to balance their risk, they may go into the market and buy stock, pushing up the share price.
The Buy-Back Program
It was most interesting to read that absolutely no additional shares beyond the $175 million previously disclosed were bought back in the latest quarter. I had guessed much of the run-up in the stock since the last announcement was due to the company's buy-back program (as well as the 20 million short shares that were covered). But I was wrong. Other people must be buying the stock. It is good news that the company still has $325 million authorized to use to buy back stock. Not only will this push the price higher, but earnings will be divided by a smaller number of outstanding shares, so earnings per share will be higher.
Analyzing The Analysts' Questions
Most of the questions seemed to center on the cash flow situation. Analysts seemed to be concerned about whether the company would have enough cash to carry out the 15%-20% growth that they were seeking. What changes in capital expenditures would there be? This issue seemed to loom larger than anything else. One question I would like to have seen was whether additional bank borrowing was possible.
The analysts seemed pleased with the $254 million positive cash flow number, well above the $30 million in the prior quarter, even if almost half of it came from lowering inventory levels (not a bad move in itself, as this should reduce costs and improve margins), and no cash was expended for buying back shares.
The stock has now approached the target price for many analysts. With the new guidance from management, it seems highly likely that next week, some analysts will raise their target price (or even upgrade the stock), measures that should goose the stock price a bit. (One analyst, Canaccord, reiterated its "buy" rating and raised its target from $45 to $54 just today.)
Judging Company Guidance
For several years, GMCR consistently exceeded guidance when earnings were announced. The one glaring exception was in the announcement just after the SEC's inquiry into possible accounting irregularities. It seems to me that the company got a wake-up call and decided to be especially careful in the future, both in its accounting procedures and assumptions, and in its guidance numbers. The current president (wooed from a potential top spot at Coke) came on board well after the earlier problems that may or may not have existed at the company.
There were many suggestions that the guidance given yesterday might be more conservative than usual (if you look between the lines). For example, earnings-per-share numbers were not discounted by any stock buy-backs that might take place. And margin projections did not take into consideration any savings that might result from several expense-reducing programs that the company had recently instituted.
I must comment on the trade I recommended on Monday in "Why Green Mountain Coffee Roasters Will Soar This Week" -- buying Jun-13 40 calls and selling Feb 2-13 47 calls (when the stock was trading just over $47). It could have been bought for less than $7, the intrinsic value while the long side had five more months of life. I paid $6.80 for my spreads. As I write this on Thursday, the stock is at $47, and the spread could be sold for $8.90 (natural price) for a gain of over 30%.
I am hanging on to my Jun-13 40 calls and will sell out-of-the-money calls against them each week, hopefully recovering some of my original cost every week, as well as enjoying any higher stock price that might come along. Sometime in early May, an earnings announcement will once again be on the agenda, and I should be able to sell at-the-money calls for more than half my original $6.80 investment (and maybe for more than my net investment at that time).
In one Terry's Tips portfolio, I placed what I called a "relatively safe" bullish bet, buying Apr-13 46 puts and selling Feb 2-13 48 puts. We paid $.62 for the spread (and incurred a $190 maintenance requirement for each contract). I placed an order to sell the positions on Thursday at $1.24, double what we paid. It executed around noon. Of course, we could have made more if I had waited it out a bit, but doubling our money had a nice ring to it for the 20 hours we held the options.
In summary, the earnings announcement was just about what I expected, but I was disappointed in the market's reaction. I should have omitted "This Week" in my first article, and made it "Why Green Mountain Coffee Roasters Will Soar in Price." I feel confident that three months from now, history will affirm my projection for the reasons listed above.
Disclosure: I am long GMCR.