Green Mountain Coffee: A Prime Short Candidate

| About: Keurig Green (GMCR)

Green Mountain Coffee (NASDAQ:GMCR) shot up after hours as sales easily beat analyst expectations and the company drastically raised its projected sales growth for the year from 45 to 53% to 70 to 80% (see earnings results here).

At today's prices, shares represent a screaming short. The stock trades for over 31x its reaffirmed guidance. Given the company's TTM ROE is a mundane 12.4%, and its ROIC may well be below its cost of capital, the multiple seems excessive. Throw in the fact that its sole offering has a faddish feel to it and the company's history of shoddy accounting and poor disclosure (which led to a now closed SEC investigation), the multiple seems downright crazy, especially considering it ignores the "one time" charges that have become commonplace with the company.

True, the company has an impressive history of earnings growth. Operating income has grown from $18.1m in 2006 to $138.8m in fiscal 2010, and net income per share has grown from 8 cents per diluted share to 58 cents per diluted shares. However, its extraordinary growth hasn't resulted in much growth for shareholders, as it's been funded almost entirely by new share issuance. Share count has ballooned from 8.4m to 79.5m, and operating income per share has actually DECREASED, going from $2.15 in 2006 to $1.90 in 2008 to $1.75 in the most recent fiscal year.

On a per share basis, the underlying business is earning LESS than it was five years ago. Growth in EPS has come entirely from issuing shares at extraordinarily high prices, which is then used to pay off debt and reduce interest payment. In effect, they are issuing equity with a yield below what they pay on their debt, so as they raise equity they increase EPS, which increases the stock price and multiple, allowing them to repeat the virtuous cycle.

One thing I found notable about the company's increased guidance is that they kept EPS forecast steady at $1.19 to 1.23 (excluding charges). In other words, all of this increased revenue won't be accruing any real benefits in terms of profits, as the company is drastically eating into its margin to pump revenues up. The company's strategy has been to sell its brewers at cost, hoping to make a profit from the sale of K-Cups (a razor blade model). What's most likely happened is the company is selling the profitless brewers like hot cakes, but can't move any of the K-Cups. In other words, the razors are selling like crazy, but they can't push the blades, which is where all the profit is.

In sum, you get a company that has grown exclusively by raising equity at high multiples to fund a business with single digit ROIC. It will grow like a weed this year, but none of the growth is flowing through to the bottom line, and the company's increase in EPS over the past several years has come exclusively from paying down debt by raising equity at lower cost and funding growth through equity. The fact that their product has all the makings of a fad and their accounting and disclosures practices have proved shady over the years is just icing on the cake.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.