Green Mountain Coffee Roasters (GMCR) has been one of the most successful stocks the market has ever seen. In the past 5 years, the stock has risen by over 2,700%, while the S&P 500 (SPY) has fallen over 8%. Its performance since IPO'ing in September 1993, is even more impressive, with the stock increasing by over 15,400%, trouncing the S&P 500's 165% gain. But along the way, there have been many concerns about the stock, and recently, David Einhorn raised some of his own.
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David Einhorn and his firm, Greenlight Capital, are among the most repsected and successful investors on Wall Street today, and when he speaks, we listen carefully. While his investment track record isn't prefect (can anyone's be?), he is far more successful than the average fund manager, with successful investments such as shorting Lehman Brothers. On Monday, Einhorn criticized Green Mountain Coffee Roasters, attacking the company's accounting, patents, valuation, and deal with Starbucks (SBUX). The stock promptly fell 10%, as Einhorn's reputation dealt a blow to the stock. The question is, is Einhorn right in his assessment? We explore this below.
Einhorn's issues with the stock are by themselves, nothing new. The concerns below have followed GMCR around for years. What is new, however, is the source of these concerns, which we list below.
- Accounting issues: The SEC has been investigating GMCR since late 2010, due to questionable accounting practices. Einhorn's investigation involved talking to employees of GMCR, both current and former, and they said that GMCR ships products between facilities and books it as revenue. If true, that would be a clear case of accounting fraud. However, the SEC has uncovered little of substance in over a year of investigation.
- Disclosure: GMCR has been criticized for its murky disclosure, and EInhorn, along with other investors have been pressing for improvements in disclosure.
- Patent expiration: GMCR's patent on K-cups expires in September 2012, and it could allow competitors to make pods for GMCR's Keurig machines, undercutting profit margins
- Starbucks, Dunkin (DNKN) and Smucker's (SJM) deals are less profitable than expected: GMCR earns around $0.15 per K-cup it sells on its own, but filings show that K-cups licensed to Smucker's earn around $0.06 per K-cup. GMCR has said many times that the Starbucks and Dunkin deals would be the same, so investors should expect falling profit margins.
- Capital investment: GMCR's capital spending is going to be 130% of net income in 2011, and will most likely rise to 200% in 2012, resulting in negative cash flow.
- Insider selling: SEC data show insiders have sold over $172 million of stock year-to-date, and most investors see net selling as a red-flag.
- Valuation: At a P/E of 80, investors may begin to question that multiple as Einhorn attacks the stock.
Green Mountain has certainly been a controversial stock, but so far, the bulls have been right. The question is, will they continue to be right in light of Einhorn's thesis? The following factors should support the bulls:
- Starbucks, Dunkin and Smuckers waited to strike a deal this year. If GMCR was about to collapse due to its patent expirations, why would Starbucks and Smuckers strike a deal? Obviously they are assuming GMCR will be around to fulfill its end of their contract.
- Growth" Net sales soared 127% in the most recent quarter. Few, if any companies have that kind of growth. Not even Apple (AAPL) can match that kind of sales increase
- Expanding market share: GMCR estimates that 25% of all coffee machines sold in the quarter were K-cup brewers. Given that this 25% is growing far above the other 75%, we think that Green Mountain will increase its market share.
- Forward P/E: Though the P/E ratio is 80, the forward P/E is under 32, a huge fall, implying huge growth for the company. Given that the company is expected to grow earnings and revenue by 60%, is it that expensive?
- Patent expirations are a positive: The patent expirations occurring in 2012 are a net positive for GMCR, because a lack of license fees mean cheaper K-cups, expanding demand for brewers that ARE patent-protected. Furthermore, focusing on brewers will turn them into a profit center for GMCR if it cannot earn enough from K-cups.
- Acquisitions have all been done to prepare for patent expirations: GMCR has been criticized for questionable acquisitions, such as Van Houtte and Diedrich. But, the net result of these acquisitions is that Green Mountain now owns its top selling K-cup providers, which means that ironically Green Mountain is the prime beneficiary of its own expiring patents
- New products: GMCR is developing new products, including an espresso machine, and a new Keurig filtering system, which will come with their own patent protections.
Green Mountain Coffee Roasters is clearly a very controversial stock, with a clear set of issues, and a clear set of catalysts. Analysts, by and large support the stock, and the Reuters average price target is $121.50. Earnings estimates have been climbing in the last few months, a rarity in this climate. The company is projected to earn $1.65 this year, and $2.61 in 2012, up from $1.48 and $2.14 just 3 months ago. Green Mountain Coffee Roasters has roasted short-sellers so far. Whether or not it will keep the success story alive is anyone's guess at this point. We have laid out arguments both for and against GMCR, and invite investors to make a judgment on the stock based on the data above. We are content to sit this one out. We know that we may miss the upside in this stock, but we could also be protected form the downside. For other investors however, GMCR may be a worthwhile investment, and we hope the information above assists readers in deciding whether or not to invest in Green Mountain. But, whether it will be a worthwhile long or a worthwhile short is anyone's guess.
Disclosure: I am long SBUX.