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Coffee stocks have been on a real tear lately -- just ask the shareholders of Caribou, Peets, Farmer Brothers (NASDAQ:FARM), and Green Mountain Coffee Roasters (NASDAQ:GMCR). The first two were acquired by Joh. A. Benckiser at a 30% premium, while FARM has more doubled. The real star of the group was GMCR, hitting a grand slam with a 300% gain in less than six months. One coffee company that has seen little love from Wall Street is Coffee Holding Co. (NASDAQ:JVA). It has actually dropped 30%, and is now selling at the bottom third of its one-year trading range.

Since the stock market is essentially a merchandising operation, it makes sense to buy stocks when they are cheap (wholesale) and sell them higher (retail). Obviously, after their dizzying runs both FARM and GMCR are selling for retail, while a 30% shellacking has put JVA in the wholesale category for sure.

Coffee Holding is involved in three operating segments: 1) private label coffee, 2) branded coffee, and 3) wholesale green coffee. The company is in the process of tweaking its revenue mix to enhance margins. It has been reducing its emphasis on low-margin wholesale green coffee sales, while focusing on its higher margin private label and branded lines. So far, this strategy seems to be reaping rewards as the company's gross margin swelled from 7.9% to 11.8% during its first quarter, despite a significant reduction in sales.

The Pros and Cons of Owning JVA

The positives are as follows:

  1. The company is undercovered and underowned. The sole analyst who provides coverage is Roth Capital, with a $10 price target in place. Institutional ownership is practically nonexistent, at just 500,000 out of 6,370,000 shares outstanding. This lack of ownership implies that once interest evolves in the shares, there should be no large sellers in the picture.
  2. It has a cash dividend yield of 3.5%.
  3. The company has a pristine balance sheet containing no debt, and an impressive cash-to-market-cap ratio of .20.
  4. It telegraphs a relatively low valuation of only 1.7 times book and 9 times 2013 estimated earnings of 75 cents.
  5. Its low valuation makes it vulnerable as a takeover target.

The negatives are as follows:

  1. It has to deal with the whims of the commodity markets, and could lose from hedging contracts.
  2. The company seems to be shareholder apathetic -- it doesn't even present at a single solitary investment conference. The organization also possesses a primitive web presence (via its website/social media).
  3. Operating expenses went the wrong way, rising 3.6%.
  4. It does not have a stock buyback plan in effect.
  5. It owns no real estate.

The bottom line: It is a "no brainer" that JVA's positives far out weigh its negatives, and its stock should be bought. Its risk/reward ratio is definitely compelling. Computed with an upside potential of 45% and downside risk of just 15%, the ratio of 1:3 means you are risking $1 in order to earn $3. Add in the fact that its short interest tally of 1 million shares is quite large in relation to its shares outstanding, and you have the bonus of plenty of potential buyers emerging in case of a short-covering squeeze.

Disclosure: I am long FARM and JVA. I am also short GMCR. 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.

Source: Coffee Holding Co.: Wake Up And Smell The Java