3 Coffee Stocks to Avoid

Includes: DNKN, GMCR, PEET
by: Bret Jensen

Over the last six months there has been much talk about various commodity bubbles, primarily in gold and oil. However, equities in these areas seem reasonably priced despite the run up over the last few years in underlying gold and oil prices. For instance, Barrick Gold (NYSE:ABX) is trading at just over 10 times this year’s projected earnings and Chevron (NYSE:CVX) is selling at just eight times 2011’s consensus EPS. However, there is a bubble in one commodity that no one ever mentions. It appears we are in a “Coffee” bubble with several stocks looking severely overvalued.

Green Mountain Coffee Roasters (NASDAQ:GMCR): Green Mountain Coffee Roasters, Inc. operates in the specialty coffee industry in the United States and internationally. It sells approximately 200 whole bean and ground coffee selections, cocoa, teas, and coffees. The company offers Arabica bean coffee, including single-origin, Fair Trade Certified, organic, flavored, limited edition, and proprietary blends under the Green Mountain Coffee, Tully’s Coffee, and Newman’s Own Organics brand names. It also manufactures gourmet single-cup brewing systems and markets its patented single-cup coffee and tea brewing systems for offices and homes under the Keurig brand name.

Overview – Green Mountain has absolutely destroyed shorts in the last year as it has quadrupled from its 52 week low. It recently reported earnings that blew away both earnings and revenues estimates. The stock correspondingly popped up an additional 15 points as shorts were forced to cover. However, the stock is looking increasingly frothy for myriad reasons:

  1. Green Mountain has a $15B market cap yet only produced a combined operating cash flow of $30mm from FY2008 to FY2010. To put another way, Green Mountain is sporting a market cap that is 500 times the amount of operating cash flow it delivered in the three fiscal years of 2008 – 2010.

  2. It is selling at the very top of its five year valuation range based on P/E, P/S, P/B and P/CF.

  3. The moat around Green Mountain’s main product (single serve coffee) is not wide. Both Nestle (OTCPK:NSRGY) and Starbucks (NASDAQ:SBUX) have competing products.

  4. Green Mountain is highly vulnerable to rising coffee prices and/or any significant market pullback that should hit high beta stocks such as GMCR especially hard.

  5. Its method for accounting for reserves and returns has been heavily criticized for being overly aggressive.

  6. Green Mountain sells for 130 trailing earnings, almost 8 times trailing revenues, and a five year projected PEG of nearly 2. Pricey by any standard.

Peet’s Coffee & Tea (NASDAQ:PEET) – Peet’s Coffee & Tea, Inc. operates as a specialty coffee roaster and marketer of fresh roasted whole bean coffee and tea in the United States. It offers whole bean coffee and related products consisting of products for home brewing, tea, and packaged foods; and beverages and pastries. The company also provides brewing equipment for coffee and tea; paper filters and brewing accessories; and branded and non-branded cups, saucers, travel mugs, and serve ware. Peet’s sells its products through various channels of distribution, including grocery stores; home delivery, office, restaurant, and foodservice accounts; and company-owned and operated stores. As of January 2, 2011, it operated 192 retail stores in California, Colorado, Illinois, Oregon, Massachusetts, and Washington.

Overview – Peet's recently hit an all-time high, even though earnings growth appears to be slowing from the average of 22% annually it has achieved over the last five years. The stock has gone up approximately 80% over the last previous 52 weeks but any investor who does due diligence should have the following concerns:

  1. Peet's is selling at the very top of its five year valuation range based on P/B, P/S and P/CF.

  2. Technically, it looks like the stock is forming a large topping pattern (Click on chart below to enlarge)

  3. Insiders have sold over 40% of their shares in the last six months.

  4. Earnings estimates for both 2011 and 2012 have come down significantly over the last three months despite the stock hitting recent all time highs.

  5. Peet's is vulnerable to rising coffee prices

Dunkin Brands Group (NASDAQ:DNKN) – Dunkin Brands Group, Inc., together with its subsidiaries, owns, operates, and franchises quick service restaurants worldwide. It franchises restaurants under Dunkin Donuts and Baskin-Robbins brands. As of March 26, 2011, the company had 9,805 Dunkin Donuts points of distribution, including 6,799 in the United States and 3,006 international points. The company has 6,482 Baskin-Robbins points of distribution comprising 2,523 in the United States and 3,959 international points.

Overview – Dunkin Brands recently priced its IPO at the top end of its range and then proceeded to pop over 45% on its first day of trading. However, beneath its successful debut lie concerns that would make me reluctant to buy the stock at these levels:

  1. It is priced at 17 times EBITDA compared to industry leader Starbuck’s 13 times EBITDA

  2. Unlike Starbucks, it is highly leveraged with debt at 4 times EBITDA

  3. Would Bain Capital and Carlyle be cashing out if prospects were that stellar?

  4. Dunkin comes public with a large debt load of $1.5B, which may slow expansion plans. Also, its Baskin Robbins business has much lower margins than Dunkin Donuts.

Disclosure: I am short GMCR.

Additional disclosure: I am short GMCR and may become short on PEET in next 72 hours. Both through out of the money bear market call spreads.