After the bell on Wednesday, coffee company Green Mountain Coffee Roasters (GMCR) reported its fiscal fourth quarter results. Overall, it was a very mixed report, with a number of great items, but also some bad ones too. The company also greatly expanded its capital return plan, which also is a mixed signal in some respects. Today, I'll break down the results, and explain to investors why they shouldn't be jumping on this train just yet.
Fourth Quarter Results:
I have to give credit when it is due, and the company certainly produced a spectacular fourth quarter. Revenues came in at $1.047 billion, handily beating expectations for less than $965 million. We've seen sizable beats (and misses) like this before, so it usually is just a matter of which side of the fence the results are. This time, it was the good side. In terms of the bottom line, non-GAAP earnings per share came in at $0.89, which also blew out estimates that were looking for $0.75. Over the last couple of years, Green Mountain has usually beat on the bottom line, and quite handily in the past year. Normally, revenues have been the problem, and we haven't seen a beat like this in a number of quarters. This was a great quarter.
The expanded capital return plan:
As most investors know, Green Mountain is in the process of completing a 2 year, $500 million buyback program. As mentioned on the conference call, the company bought back 778,000 shares in fiscal Q4 for 62.6 million. That averages about to $80.46 a share, which didn't look great with the company trading in the high $50s and low $60s a lot recently. The company also said on the call that it purchased $97 million worth of shares since the quarter ended. According to the 10-K filing, the company has bought back just under 1.35 million shares since the end of Q4, meaning an average price just under $72. Remember, the early part of this buyback took place when shares were in the $20s, so Green Mountain is paying three times that amount now.
Green Mountain surprised investors by announcing an expanded capital return plan. Once the company finishes the current buyback ($138 million remaining), the company will buy back up to an additional $1 billion of stock over the next two years (starting sometime in 2014). The company also declared a quarterly dividend of $0.25, which means an annual dividend of $1.00. The company said that these capital returns will be funded through cash from operations as well as the company's existing credit facility. I'll have more on this later.
This is where Green Mountain lost a little shine from the Q4 blowout. The company's fiscal first quarter and full fiscal year 2014 (ending September 2014) guidance were a little soft in most areas.
For fiscal Q1, the company guided to revenue growth in the low to mid single digits, based on difficult brewer and portion pack sales comparisons, the impact of unlicensed packs, and a Canadian currency headwind. Going into the report, analysts were looking for 7.3% revenue growth in Q1, so this forecast is definitely light. On an earnings per share front, Green Mountain guided to $0.85 to $0.90, a bit below the $0.96 analysts were looking for. In the end, I'm not as much concerned with the earnings forecast, as the company has been good with bottom line numbers in recent years. I'm more concerned with the light revenues, which I'll get into more detail in the next section of this article.
For the full year, the company expects revenue growth in the high single digits, with stronger growth in the second half of the fiscal year. The company expects to transition a number of unlicensed packs to licensed ones, which will boost revenues later in fiscal 2014. Again, this forecast is a little soft, as analysts were looking for 9.6% growth. However, the high single digits guidance isn't as bad as the Q1 guidance was. On an earnings per share front, the company guided to $3.75 to $3.85. The midpoint of that forecast is two cents ahead of analyst estimates. Again, I'm not as much concerned with earnings.
Breaking it down - growth versus reality:
There are a couple of key numbers and statements from management I want to look at in more detail. This is because there seems to be a disconnect with reality, and the company has basically pumped up some numbers that need a further examination. I am not accusing Green Mountain of anything illegal here, I am just saying that management could have changed the tone a little bit to provide a more accurate portrayal of the situation.
First, here is a quote from CEO Brian Kelley in his opening remarks on the conference call:
These capital allocation decisions do not change our status as a growth company. To simply put, we reviewed our free cash flow outlook to nearly $1 billion in EBITDA we generated this past fiscal year, our net cash position and available borrowing capacity and we saw an opportunity to further optimize shareholder returns.
Sorry Mr. Kelley, I must respectfully disagree. You may want to review your company's history over the past couple of years. In fiscal 2010 and 2011, the company had revenue growth of 72.59% and 95.38%. In fiscal 2012 (which contained an extra week), revenue growth was 45.58%, and in the just announced quarter, it was 12.93% (higher if you normalize the previous year). In the current fiscal year, the company is guiding to high single digit growth. Additionally, in the 2011 and 2012 fiscal years, Green Mountain had revenue dollar growth of $1.294 billion and $1.208 billion. In fiscal 2013, that number was under $500 million (higher if you normalize), and in fiscal 2014 guidance implies less than $500 million. Sorry Mr. Kelley, but Green Mountain is no longer the growth company that it used to be, in either percentage or dollar growth terms. In fact, your revenue growth isn't expected to be that much more than that of Apple (AAPL) for the same fiscal year. We all know the Apple story and how many will tell you Apple's growth days are over. In fact, many called Apple's growth dead after the resumption of the dividend and a huge buyback. Isn't that basically what Green Mountain is doing here?
The Apple story is a very interesting comparison to bring up. In my opinion, it all has to do with perception. Apple is no longer a pure growth company. When Apple initially launched the $10 billion buyback and dividend, the company was in a transitional period to a value name. When Apple increased the dividend by 15% and the buyback by $50 billion, Apple took a large step forward to being a value name. It's the same here with Green Mountain, although to a different extent. Green Mountain first announced a $500 million buyback, at which point was really significant with shares trading in the teens. But this new Green Mountain plan is a huge step forward to being a value name. First, at Wednesday's close, the announced dividend represented 1.62%. That's not exactly a small dividend, as the annual yield would be about 25 basis points more than a 5-year US Treasury. The billion dollar buyback also represented more than 10% of the market cap as of Wednesday's close. So this was a large plan, and thus Green Mountain is no longer a full growth company in my opinion. Is it a complete value name yet? Maybe not, but a giant step forward was taken this week. For the CEO to say that the company's growth status has not changed is completely wrong in my opinion.
Breaking it down - free cash flow questionable:
The second very important item I want to get to is free cash flow. In the "performance highlights" section of the earnings release, the company issued the following statement (1 below), followed by another statement further down (2 below) in the release.
- "Importantly, for the year, free cash flow generation of $603 million was nearly eight times last year's $77 million."
- "Our strong fiscal year 2013 free cash flow of $603 million, which was 125% of GAAP net income, resulted from a healthy balance of net profit growth, lower inventory levels on the working capital side and lower capital investment."
If you didn't see the second statement further down in the press release, you would have thought that this free cash flow was tremendous in the fiscal year. Even reading statement 2 above, you still would be fairly satisfied. However, an examination of how these numbers came to be is definitely warranted.
First, and I've explained this several times in my past GMCR articles, the company is not investing heavily in the business. Maybe that's why revenue growth is so slow. In fiscal 2012, the company first started out by saying it would have capex of $700 million to $780 million. As I detailed in a past article, that number was continually reduced. In the end, the company had capex of $401.1 million, well below what originally was guided to. Then we get to fiscal 2013, the year that just ended. Originally, the company guided to $380 million to $430 million in capital expenditures. Don't forget, it also guided to 15% to 20% revenue growth and that didn't happen. A few months ago, when the company issued third quarter results, it guided to capital expenditures of $275 million to $325 million. But what did it end up with? Well, the cash flow statement for the year and 10-K both say $232.8 million. So not only did it reduce the forecast throughout the year, but the company cut another chunk out in Q4.
So by heavily cutting capital expenditures, the company was able to significantly boost free cash flow. Remember, cash flow "was nearly eight times" what it was the previous year, jumping by $526.5 million to $603.2 million. But if the company boosts its cash flow by cutting investments in the business, it could be sacrificing long-term growth. By increasing capital expenditures, you would think that revenue guidance would have been a bit higher. The reduction in capital expenditures over the prior year equaled $168 million, or 32% of free cash flow growth.
But that's not the only boost to free cash flow. The company also referenced lower inventory levels. By not replenishing inventory (which may have been too high to begin with), inventory changes on the cash flow statement went from a negative $92.86 million to a positive $87.68 million. That's more than a $180 million difference, which equaled 34% of free cash flow growth.
But I'm not done yet! The company also improved cash flow by not paying its bills. Yes, accounts payable and accrued expenses, which totaled $17.13 million (towards the positive) in cash flow in fiscal 2012, totaled over $133.5 million in fiscal 2013. That's another $116 million plus, or 22% of free cash flow growth.
Holding all else equal, you could make the case that by not investing in the business, lowering inventory levels, and not paying bills accounted for more than 88% of the company's free cash flow growth. The problem for the company is that these numbers will soon reverse. Green Mountain guided to just $200 million to $300 million in free cash flow for fiscal 2014. In that, the company guided to capital expenditures of $400 million to $450 million for new system introductions. Yeah, I'll believe it when I see it that it actually spends that much. I'm sure the company will tout "better than expected free cash flow" a few quarters down the road by making certain "adjustments" like the ones mentioned above.
It will be interesting to see how much debt the company takes on to accomplish the buyback and dividend. The company had a little more than 150 million shares outstanding at the end of the fiscal year (which probably has come down), so right there, that's about $150 million per year for the dividend. Additionally, the company's cash balance was just $260 million at the end of fiscal 2013, and I'm guessing some of that was tied up in Canada, so it would have to repatriate that cash to the US and face some taxes. So to buy back up to $1.14 billion roughly over the next 2-3 years will require a bit of debt it seems.
What this all means:
There are a couple of key takeaways here. First, despite the CEO's comments, this is not a true growth company, not as it used to be. How will that change? Well, once the company expands into some new markets, there is the potential for tremendous revenue growth. When will that be? I have no idea, and I'm not sure if the company does either. At that point, betting against the company may not be the best idea. For now, many still are on the short side, with roughly 40 million shares short at the end of October. I'm sure that number has come down, but we'll have to wait almost another month to see how the post-earnings stock movement impacted short interest.
In terms of the dividend and buyback, it does signal that Green Mountain is more of a value investment. The true success of the buyback will depend on execution, which I know, is very difficult. With the remaining $1.14 billion approximately, the difference between the average price at $60 and $85 is nearly 5.6 million shares. That will have a large impact on earnings per share, future dividends, and some other items. It's hard to bet against a company with such a huge buyback, but part of this buyback may be 2 or 3 years off. The buyback also won't help with the main issue I see with this company, and that is revenue growth. Another revenue miss or bad guidance will certainly take this name down. Remember, revenue expectations had come down a bit since the last quarterly report, and this stock went from just under $90 to under $57 in two and a half months. That's not exactly a small move, and a drop of that size could easily happen again.
So how do you value Green Mountain? That's a good question, and it all depends on who you associate the company with. Do you think it is more like Starbucks (SBUX), the international coffee giant, or a company like SodaStream (SODA), which allows you to make your own soda at home? The following table shows some key comparisons between the three names in terms of growth and valuation. The numbers below are for fiscal 2014, which is September ending for GMCR and SBUX, and calendar ending for SODA.
My personal opinion is to look more towards SodaStream, with the razor/razor blade type model that these companies operate in. In that light, Green Mountain looks overvalued a bit, especially since it offers the least amount of growth here. Is there certainly potential for Green Mountain? Definitely. However, and this is especially true after a 14% pop Thursday, you really need to think about the above numbers. Green Mountain is now up 24% from the November 13th low, and while you might argue it shouldn't have been below $57 in the first place, I could also argue that shares shouldn't have been at $90 either. It all comes down to your view of the stock. Does the above average risk this stock carries outweigh its potential?
While Green Mountain had a blowout Q4, the company's guidance was not spectacular. It is apparent that unlicensed k-cup packs are having an impact on the business, and Green Mountain believes it can convert them to licensed packs going forward. Additionally, the company announced a new larger buyback and initiated a quarterly dividend. The company believes it still is a growth company, but I don't fully believe that anymore. Revenue growth has gone from 95% to the single digits in just three years. The company also boasted a huge year in terms of free cash flow, but that was mostly due to shrinking inventories, not paying the bills, and slashing capital expenditures for the second straight year. Green Mountain will be a tremendous name to be in once the company embarks on an aggressive international expansion plan. But until then, this name will be a quarter to quarter one, and it will have to have a solid holiday season (although it might have sandbagged the quarter to where it can't miss). What's the trade here? Well, I'm never a fan of a tremendous revenue growth slowdown, and the cash flow game is just hilarious. Just like last quarter, I think Green Mountain will be a great short candidate after a couple of weeks. Last quarter, shares dropped from nearly $90 to $57 in just two-and-a-half months. Should Green Mountain continue this rally towards $80, it will definitely be worth a look as a short.
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.