Green Mountain Coffee Roasters: Starting At Base Camp

| About: Keurig Green (GMCR)

Driven by the emergence of upscale coffee shops in the country and consumer knowledge and appreciation of specialty coffee and tastes, Green Mountain Coffee Roasters' (GMCR) investors have been on quite a ride in the past year. It is tough to argue with success of the company, but innovation in business is very important.

Coffee beans are agricultural goods. There is risk in production, weather and marketing. All of these factors affect how much consumers pay for their morning cup. How long until vertical integration takes over the entire industry? What new products and services will GMCR offer to keep it ahead of the competition? What stops a competitor, or someone they have a license agreement with, from developing a similar product at less cost?

The previous paragraph shares some obvious concerns both for the industry and GMCR. The past several years have shown primary growth from specialty coffee sales. According to the company's information released in its Annual 10-K Report, Green Mountain Coffee Roasters’ Kuerig, or K-Cup, is the driving force of the company’s income. It sells the brewing machines at a net loss in an attempt to gain licensing agreements with larger companies to distribute the K-Cup. Brew machines are basically vending machines. The products coming from them are the real money makers.

GMCR's Annual 10-K Report also stated the company is looking to move into Canada, along with continued expansion in North America. Smaller growth areas will receive attention from license agreements with Starbucks (SBUX) and Dunkin Donuts (DNKN). These are multi-year licensing agreements started in 2011.

Continued information from the report shows that:

"K-Cup sales accounted for 84% of the consolidated net sale of the company in fiscal year 2011. Currently 200 varieties of K-Cup are available for the brew machines. The Company’s net sales of $2,650.9 million was comprised of $1,704.0 million K-Cup net sales, $524.7 million K-Cup single-cup brewer and accessories net sales and $422.2 million of other product sales."

The company responded to allegations that it recorded a reversal of expense related to the provision for sales returns, or the sales returns reserve during the quarter ended March 26, 2011. GMCR has gone to great lengths to prove it position that this did not occur. As stated by a press release from the company's website:

“In response to an increase in sales returns over historical levels related to the Company's Keurig® Single-Cup Brewers experienced in fiscal 2010, the Company determined to provide greater transparency in its Consolidated Statements of Cash Flows by reporting the effect of sales returns as a separate adjustment when reconciling net income to net cash provided by operating activities. Prior to September 25, 2010, the effect of sales returns on cash flows provided by operating activities was reported on a net basis within the change in accounts receivable adjustment line in the Consolidated Statements of Cash Flows.”

Basically, the company changed the category where it reported the dollars to the public. It insists this was done to provide greater clarity, yet this was not the case in the previous 12 months. In the same press release, Green Mountain also mentioned: "We completed testing of the design and operating effectiveness of enhanced controls. As a result, as of September 24, 2011, we concluded that we had remediated the previously reported material weaknesses in our internal control over financial reporting." Rapid growth in the company may have led to the errors.

Companies may be punished by investors when accounting irregularities arise. It is often suggested that a year or more should pass before looking into investing in a company is this situation. Fundamentally, the company does have strong attributes that investors should be looking for. ROIC, return on invested capital, at 10.48% shows the company’s ability to invest earnings at a profitable rate. Profit margins are also attractive at 7.53 percent. The company also has a sizable short interest at this time. Investors have been willing to pay more for earnings at Green Mountain Coffee Roasters as it nears 41 times forward earnings.

If an investor chooses to overlook the accounting problems as a one-time event not to be repeated, then the company deserves a good look at these levels. As mentioned earlier, several factors can move against this company in a short time. This stock could be used as an investment, but should be monitored against headline news and reevaluated as needed.

Green Mountain Coffee Roasters stock finished trading $53.92 up $1.49 (2.84%) Thursday.

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

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