Try as they might, management at Green Mountain Coffee (GMCR) cannot seem to get their arms around how to run a business properly. Sure, the stock is cheap now, but it is cheap for a reason.
GMCR has been selling coffee for a long time and has been a public traded company since 1993. So, to hear management say that they found it difficult to predict with any certainty, sales trends (referred to as a "disconnect"), sounds like a poor excuse to rationalize inventory and liquidity problems in recent years.
As an investor, you have to ask yourself an important question. Why would you invest in a company that has over the course of several years failed to effectively address their internal control issues? How much time does it take to figure things out?
In addition, we have noted on many occasions in the past, our concerns about the company's accounting practices. We are not alone in this camp as other accounting sleuths (including Sam Antar, Grumpy Old Accountants, Dan Yu, Ben Strubel, to name just a few) have provided a plethora of informative observations regarding the lack of transparency and anomalous relationships manifested within GMCR's financial statements during the past few years.
Not to mention the fact that the SEC is still engaged in an ongoing inquiry of GMCR for several years now.
Although we believe fiscal year ending 2011 marks what appears to be a company seemingly realizing that it might have been pushing the accounting envelope too far, not much has been done to remedy the issues plaguing the company since.
Ousting former chairman Stiller was a no-brainer and this should have occurred much sooner. But, you still have this unexplainable hyper-growth in recent years and little to show for it. Add to that tempered comments from management about future growth expectations:
"As we continue to meet (that) demand and become larger, our growth trajectory will understandably moderate from hyper growth levels to something more in line with other successful growth companies" (Larry Blanford President & CEO from Q3 transcripts)
As to what or whom CEO Blanford is equating his firm with other "successful" growth companies we are not quite sure. The difference between successful or not depends on how one defines success. But the bottom line here is, growth for GMCR will not likely resemble anything the company "reported" in previous years.
The problem is when a company "matures" its previous capital expenditures and investments (as a means to fuel future growth) should be realizing returns on: equity, assets, investments, etc.
These are the gears from which even a moderating growth story should be expected to generate sufficient if not excess free cash-flows in the future.
Unfortunately, this has not been the case at GMCR. This is not a high tech company where R&D spending drives future profitability. The coffee business is a gunk-to-widget operation. The argument that fast-growing companies reinvest operating cash into the business is valid during early growth cycles, but GMCR is not a nascent player.
Earnings...what earnings? What makes GMCR so excellent a study in this regard is that as the company was so proud of the fact they were growing like a weed, this "growth" never added any punch to the punch-bowl. Any punch (i.e. liquidity) that did make it into the bowl came via well-promoted secondary offerings, not operations. That's not organic growth, it's a dog and pony show.
On the issue of declining gross margins, the company laid blame to the combination of under utilization of their current manufacturing base and the resulting efforts to reduce K-Cups pack inventory.
When you make something and sell it (or grow it and sell it) margins are dictated by how efficient management is with cost controls and their ability to pass higher input costs on to the customer.
In some cases, discounting is the mechanism by which companies grow market share, but it comes at the expense of margins. Other influences beyond the control of management would be commodity prices for coffee.
What we see is a company doing a lousy job of circumnavigating their corporate governance responsibilities by playing the "ignorant card". They might as well be saying: "Well, during the past few years we grew fantastically, but we haven't got any cash-flow nor do we expect any in the near future. Oh, and by the way, we grossly miss-calculated our capital spending habits; the inventory aberrations and capacity issues were not what we expected. And, we don't expect to grow as fast as we did in previous years."
Learning curves are sometimes steep, but the real disconnect between GMCR's admitted difficulty in managing its growth is also a sharp contrast to the well documented concerns of the company's accounting irregularities.
Yet, it requires some skill of accounting to construct the financial statements. It is far more dangerous for executives of public companies to imply that "stuff' happens without first attempting to match their story with the one being told in the financial statements.
Those of us who raised concerns about GMCR as its share price blasted skyward were lambasted by critics and GMCR bulls as "bashers" and harbingers of evil to the mighty Green Mountain story. In reality, had investors heeded warnings from folks like Sam Antar (who has in our view provided some of the most thorough and detailed analysis out there), it's a good bet there would be fewer GMCR bulls with clipped horns.
Regardless of what progress the company may be attempting or expecting to accomplish going forward, the past few years remain thoroughly unaccounted for. Management has yet to reconcile the financial statements satisfactorily and the muted back-pedaling (disguised as an effort to fix the mess) does not help the investment case or their credibility.
We use a combination of dual cash-flow, accrual and capital productivity analysis to help us gauge the financial health and quality of earnings being reported by companies. In the case of GMCR, a review of the previous five quarters (through June 23, 2012) suggests that the stock remains significantly overvalued even at these current distressed levels.
For details of our analysis, readers can view the complete and entire GMCR report here .
Until GMCR management is willing or able to provide complete transparency regarding their accounting practices, it will take more than good coffee or the convenience of a freshly brewed cup of java to lift these shares higher. For those of you impressed by GMCR's recent rebound...think short covering.