Bitter Beans at Green Mountain Coffee

Sep.30.10 | About: Keurig Green (GMCR)

Click to enlargeThe SEC inquiry into Green Mountain Coffee (NASDAQ:GMCR) along with the company’s own
admission to a cumulative overstatement of net income in 2007, should not come as
a surprise. Neither should the 15% shellacking its shares got in after hours trading Tuesday.

Sarbanes Oxley couldn’t have prevented it, because the legislation never had teeth to begin with. And, trying to interpret FASB Codification rules would give even the smartest CPA a headache. Between conflicts of politics, lobbyists and human nature, some things will never change.

However, an average investor keeping an eye on recent changes in GMCR’s financial statements should have been able to spot the red-flags well before the shares were turned into chutney. (Note: Our analysis covers the seven quarters ending June 26, 2010.)

The balance-sheet looks like a roller coaster. Receivables, inventory, PPE and accounts payable are all over the map. Days-sales-outstanding show consistency, but changes in income producing assets don’t jibe with changes in revenues.

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A 69.4% jump in June 2010 inventories on a -4% drop in sales catches our eye. The build-up in PPE versus sales during review periods also brought a groan. Sure, GMCR has been in acquisition mode lately, but, the added capacity and a build-up of inventory (against declining sales) tells us they’re not getting a decent return from these assets.

Current non-cash “other” assets also spiked in recent quarters. Other assets, aren’t usually converted into cash and don’t typically play a direct role in generating income. Although GMCR’s “other” current assets account for a small percentage of total current assets, the recent trend is noticeable.

Growth of payables for the latest period is highest of all periods reviewed and glaringly larger than sales in the similar quarter. Even big companies like Proctor and Gamble (NYSE:PG) stretch payments to suppliers, but GMCR appears intent on keeping whatever cash it can.

Our dual cash-flow indicators also point to a steady deterioration of earnings quality in recent quarters. For example, declines in operating cash-flow as a percentage of revenues are more than offset by increases in non-cash (balance-sheet) cash flows.

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Declines in capital productivity also seem to verify GMCR’s difficulty in extracting synergies from its recent acquisitions. However, the most obvious culprit of the company’s trouble can be seen in the parabolic accrual ratios. It’s been a while since we’ve seen such dizzyingly high figures.

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I have no macro opinion of the coffee business except to know that rainfall in Brazil has a tremendous impact on its commodity price. Bottom line though, in a volatile market like this, being aware of earnings quality and cash flow, might help prevent the coffee from burning.

Disclosure: No position