Green Mountain Coffee Roasters (GMCR) is among the largest specialty coffee producers in the U.S. Its founder, Robert Stiller, became a billionaire after the company announced its strategic collaboration with Starbucks (SBUX). Instantly, the stock moved up by almost 45% in March of 2011. Since then, the stock kept going higher and higher until the last September. The stock tested its $110 resistance twice, and literally collapsed after David Einhorn's bearish comments at the value investment conference of 2011. The stock kept sliding, and lost almost 50% of its value in the last month alone. Since last October, the shorts made a good sum of money on GMCR, as the stock was trading for as low as $24.9 at the time of writing.
At the current valuation level, GMCR stock is trading at the bottom of its 52-week trading range of $24.03 - $115.98. It has a market cap of $3.9 billion. Trailing twelve month [ttm] P/E ratio is 11.8, and forward P/E ratio is 8.3. P/B, P/S, and P/CF ratios stand at 1.8, 1.1, and 16, respectively. The 3-year annualized revenue and EPS growth stand at 74.3% and 89.2%, respectively. Operating margin is 15%, and net profit margin is 9.5%. The company does not have much debt. Debt-to-equity ratio of 0.2 is well below the market average of 1.1. GMCR does not pay any dividends.
GMCR has been a Wall Street darling since 2007. It has always been trading with high multiples. The company has a 5-year average P/E ratio of 51.2. Out of 2 analysts tracked by Morningstar, 1 has buy, and 1 has hold ratings. Wall Street has diverse opinions on GMCR's future. The bottom line is 50% growth, whereas the top-line growth estimate is 77.5% for the next year. Average five-year annualized growth forecast estimate is 35%.
What is the fair value of GMCR, given the forecast estimates? We can estimate GMCR's fair value using discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS of $2.08 along with the mean EPS estimate of $3.15 for the next year.
E0 = EPS = ($2.08 + $3.15) / 2 = $2.62
Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 35%. Since it might be claimed that this growth estimate is too optimistic, I will take half of this forecast in my model. Thus, the FED+ valuation model will assume that the annual growth forecast for the next 5 years will be 17.5%, Note that this is a pretty conservative estimate given the company past earnings growth. Book value per share is $13.84
The rest is as follows:
Fair Value Estimator | ||
V (t=0) | E0 | $2.62 |
V (t=1) | E0 (1+g)/(1+r) | $2.77 |
V (t=2) | E0((1+g)/(1+r))2 | $2.93 |
V (t=3) | E0((1+g)/(1+r))3 | $3.10 |
V (t=4) | E0((1+g)/(1+r))4 | $3.28 |
V (t=5) | E0((1+g)/(1+r))5 | $3.48 |
Disposal Value | E0(1+g)5/[r(1+r)5] | $31.60 |
Book Value | BV | $13.84 |
Fair Value Range | Lower Boundary | $50 |
Upper Boundary | $64 | |
Minimum Potential | 100% | |
Maximum Potential | 156% | |
(You can download FED+ Fair Value Estimator here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for GMCR is between $50 and $64 per share. After losing almost 45% in this year alone, the stock fell deep into oversold territory.
(click to enlarge)
(click to enlarge)
Source: Finviz
Summary
Looking at the chart above, one can see huge gaps in several ranges. The first gap between $40 and $70 was filled when the stock spiked in early February. In March it slipped $50 directly from a price of $60. Most recently, it again collapsed from $50 to $30. There is a huge gap of about 40% within the first trading week of May. Looking at the stock's past movements, I think there is a high probability that this gap will be closed at some point in soon future.
Waterbury, Vermont-headquartered Green Coffee Mountain Roasters is one Cinderella story. The company offers the same coffee with a different taste, and in a more convenient form. That tiny difference in production/marketing process created a gigantic company. Its founder, Robert Stiller, recently started selling his shares, which is one of the negatives faced by the shareholders.
Another negative is the expiration of the company's K-Cup patents. It is widely rumored that the expiration of patents on K-Cup designs will trigger a flood of competitors, replicating the K-Cup designs. While it is true that the patent #5,325,765 will expire by this year, some aspects of the patent #5,840,189 will protect the market from new entrees until August 2017. (The patent issue is well explained by Fellow SA contributor, Martin Redfield, here)
Green Mountain Coffee Roaster stock has been moving in the opposite direction with the company for the last 2 years. While the company more than doubled its earnings this year, its market cap was slashed by two third in the same period. Based on a very conservative growth estimate of 17%, and a forward P/E of 7.9, the stock looks like a very cheap deal. Insider sales is a red flag, but the stock is too cheap to ignore. Apparently, the stock captured Stephen Mandel's interest, as Lone Pine Capital doubled its stake to about $6 million stocks in the last quarter. The Relative strength index of 24.5 also suggests that technically the stock is oversold. Thus, it might be a good trade for the short-term as well.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
