The bearish argument against (former) momentum darling Green Mountain Coffee (GMCR) finally caught the attention of investors this past week, thanks to Greenlight Capital’s David Einhorn in his robust 110-slide presentation before the Value Investing Congress in New York. Shares of GMCR are off some 30% since his comments.
Up until mid-September, GMCR stock had been the bane of long-established and significant positions held short. Ironically, Einhorn’s bearish thesis reiterated many concerns previously discussed in the financial media.
The Merriam Report too has highlighted its concerns of questionable accounting practices at GMCR on numerous occasions (May 9, May 4, April 29 and Feb. 13 of this year). We also note some very in-depth investigative research by Sam E. Antar, chief cook and bottle-washer over at White Collar Fraud.
It comes as absolutely no surprise to see investors flee this stock in the wake of Einhorn’s negative outlook for GMCR. We are amazed, however, as to how long it took for the bearish sentiment to manifest.
Also interesting is that several analysts affiliated with firms involved in bringing the most recent secondary to market (Janney Capital Markets and Sun Trust Robinson Humphrey) were quick to counter Einhorn and defend their bullish opinions of GMCR in recent days.
GMCR reports Q4 2011 earnings on Oct. 26. One of the key takeaways from Einhorn’s thesis that investors should pay attention to is the lack of conspicuous free cash-flow. Reported sales have been parabolic, yet the company resorted to a secondary stock offering in order to satisfy creditors (also affiliated to the lead underwriter of the recent secondary) and line the pockets of “selling stockholders” dumping a boatload of shares.
Growth companies invariably experience liquidity squeezes during growth phases, but the financial statements for GMCR reveal an ongoing propensity for non-cash accounting. At some point, a bona fide growth story should translate into a profit and earnings story with real profits and real earnings.
In GMCR’s case, serial acquisitions have been less than accretive to the earnings picture, not to mention very peculiar accounting treatment of these acquisitions in the statements of cash-flow and their representation on the balance sheet. It’s all those messy adjustments that in our view, simply don’t add-up to any semblance of "earnings quality."
Q4 Expectations: We can’t help but view the “Einhorn effect” as essentially a slap in the face to GMCR’s management. The company has not (to our knowledge) yet replied or commented on the Einhorn report, citing a “quiet period” before Q4 earnings release. So, how will Q4 unfold?
Our research indicates GMCR is and continues to be heavily reliant on balance sheet maneuvering to support earnings. If the company reports “better than expected” numbers on Oct. 26, we would be skeptical for the following reasons:
- Accrual accounting remains dangerously elevated (see chart 1)
- Geometric similarities between changes in balance sheet cash flow and operating cash flow look to good to be true (see chart 2)
That’s not to say that investors won’t use a good report as an excuse to get back into the stock. Especially now that shares are back near the level of the secondary.
Keep in mind that investors (and apparently regulators too) dismissed the dilutive effects of the secondary, the fact insiders were dumping shares and the cheerleader analysts joined at the hip to underwriters and book runners of the offering.
On the other hand, management could view the present circumstances as an opportunity to use the 4th quarter for asset charges and write-downs. Non-cash impairments won’t impact cash-flow per se, but it will be a hit on equity and earnings.
The loss in market cap is too significant to ignore, and although insider selling isn't a crime, the pace and intensity of recent GMCR insider sales simultaneous with and following the company raising capital does not offer inspiration.
Regardless of how this plays out, GMCR has been transformed from a momentum stock to a "show me" stock.