Diedrich Coffee: Piping Hot or Cooling Off?

When I last wrote about Diedrich Coffee (Nasdaq:DDRX) two years ago, it was a sleepy stock stuck in the $3-$4 range. Boy, have times changed.

After dropping well under $1, Diedrich Coffee has turned into the hottest stock in the nation, shooting up over 2000% to top $18.

The business has transformed as well. Diedrich Coffee is selling its remaining Gloria Jean’s stores and will focus now on expanding its manufacturing of K-Cups, the single serving thingies that fit into the Keurig brewing system developed by Green Mountain Roasters (Nasdaq:GMCR). Diedrich’s Coffee People K-Cups are one of the most popular grocery items on Amazon.com.

Last quarter, the new focus really hit the bottom line. Diedrich reported earnings of $.25 per share, versus a loss of $.39 in the year-ago quarter.

While the stock’s quick rise has polarized investors, neither the bulls nor the bears know at this point whether the strong results and operating margins will be sustained. All eyes will be focused on the company’s next report to see if Diedrich continues to deliver.

I’m always tempted to short stocks with this large a rise, but I won’t short Diedrich here for four reasons:

1. Technically, Diedrich is on fire. It's very close to new all-time highs and shows no signs that the action over the last week or so was anything more than a pause in the rally. It's just not safe to short here without an objective sign of weakness.
2. Low float. With a float of only 3.01 million shares, shorts can get squeezed hard.
3. Fundamentally, Diedrich appears to be executing its transformation well. No reason to believe that this changes over the coming few months.
4. Market cap is not that high. Yes, the rise has been dizzying. But even now, Diedrich is only worth around $100 million. Another few good quarters and it could easily grow into its current, or even a higher, valuation.

Bottom line: I have no position in Diedrich (DDRX) but will consider playing this from the long side as long as (a) Diedrich maintains technical strength by an objective measure (I use trade triangles but certainly another measure like 50-day MA could be used); and (b) Keurig continues to do well, which I’ll measure by both Amazon.com sales rankings and Green Mountain Coffee Roasters (GMCR) stock prices.

DISCLOSURE: No position.