Green Mountain Coffee Roasters, Inc. (GMCR) has been one of the most volatile names in this market over the past couple of years, and especially in the past year. Whether it has been earnings hits, earnings misses, the Einhorn presentation, or the partnership with Starbucks Corporation (SBUX), shares have both skyrocketed and plummeted. Recently, shares have rallied strongly after the company announced a $500-million stock buyback when it reported earnings results. But after such a large move, it might be time for the longs to step aside, as the overall fundamentals for this name really haven't changed. Let's look at some reasons why shares could head lower.
Growth Potential Still Coming Down?
Green Mountain's fiscal Q3 saw revenues of $869.2 million. Not only did that miss analysts expectations, for the third quarter out of four, but it also missed the company's own guidance for $861 million to $897 million (a midpoint of $879 million). Remember, this is a company that has spent the last few quarters revising its models and how it forecast future sales and earnings. It still missed.
Looking forward to fiscal Q4, the company gave guidance of $889.9 million to $925.5 million, a midpoint of $907.7 million. Obviously, analysts don't trust the company, which is why the consensus Street expectation currently calls for $902.7 million. Analysts aren't buying the company's forecast for 15% to 20% sales growth in fiscal 2013 either, since the current street estimate is for just 14.9% growth.
Remember, and I mentioned this recently, Green Mountain had 95% revenue growth in fiscal 2011, and the two years before that were 72% and 58% (for 2010 and 2009, respectively). For this current fiscal year ending in September, it is looking at just 44%, if it even hits that number, and less than 20% next year probably. Growth has certainly hit a wall, and analysts are even more bearish.
Buyback Issue 1: Number of Shares
Green Mountain is expected to buy back $500 million worth of shares over the next two years. I've mentioned this before, and it is pretty easy to figure out. As the share price goes up, the number of shares the company can buy goes down. It's a basic concept.
Now, shortly after the company's Q3 report was released, shares traded down to about $15.25 in that after-hours session. They've rallied since, and closed Wednesday at $25.51. The following table shows how many shares could be bought back, depending on the average price they are bought back at.
Now remember, the diluted share count is rising each quarter, primarily due to executive option dilution. In the past year, the diluted share count is up by about 2.5 million. At that pace, Green Mountain would have to buy back 5 million shares just to stop the share count from rising, and at higher prices, that eats up more of the "buyback". Investors that were hoping this company would buy back 25 to 30 million shares may be out of luck. Strangely enough, this could help the company's financial image, and I'll cover that next.
Buyback Issue 2: Hiding Growth Issues
I'm not even going to argue here about the company using cash to buyback stock instead of spending on capital expenditures, because I covered that in my last article. That is a strike against them in itself.
But here is the real issue. Green Mountain has actually been helped in recent years by an increasing diluted share count. It has actually hid most of the company's actual bottom line, or GAAP net income, growth. Earnings per share (GAAP) have risen nicely, but net income is up even more. The following table shows the year over year increase in each, plus the three year total.
GAAP earnings per share are up less than 600% in the past three years, but net income, the true bottom line measure is up over 820%. That's quite a difference!
But because the company is going to buy back shares, the trend is going to reverse, meaning that the company's true bottom line growth will be less than net income growth, and that is going to hide the true issue with this name, the lack of growth.
I'll explain how this works out. Let's assume that GAAP net income for fiscal 2012 rises 40% over the last year's figure. Since 2011 saw GAAP net income of $199.5 million, the 2012 figure would be $279.3 million. For the purposes of this argument, let's assume the company only bought back enough stock in Q4 that the diluted share count stays at the same level it was at for Q3, that is, 155.526 million. Based on the share count and net income, you have earnings per share of $1.80.
Now, let's assume that for fiscal 2013, the company has 20% net income growth. That gives us a little more than $335 million in net income. As the company buys back more stock, thus reducing the diluted share count, earnings per share rise. But the net income figure is still the same. So I've put together a table showing how this works. For instance, if the diluted share count declines by 10 million over the next year, earnings per share growth will be roughly 27.5%, but net income will still be just 20%.
As the company buys back more stock, the earnings per share growth goes up and up, but the net income is still the same. Thus, while it appears that it is doing "better" on the bottom line, it really isn't. Buying back shares may artificially improve some numbers and inflate the stock price for a short time, but the company's true health won't be impacted by it. For a company whose growth prospects have been hastily questioned in recent years, the real growth of this company is what will matter in the long run.
Two Other Preferred Names
When it comes to Green Mountain, there are always two names discussed that particularly may be better investments. Now remember, Green Mountain has been very volatile, has seen a dramatic drop-off in growth, and is still being investigated by the SEC for certain accounting issues.
On one hand, you have Starbucks. Yes, Starbucks is only growing revenues in the low- to mid-teens this fiscal year (ending in September as well) and next, with earnings per share rising a bit faster. However, Starbucks also provides a dividend, yielding about 1.4% currently. Also, Starbucks has not been as volatile as Green Mountain, and that might sit better with longer-term investors.
The other name is SodaStream International (SODA). Yes, coffee and soda are different items, but they are both drinks, and both companies allow you to make your own, coffee or soda, at home, the office, etc. The current estimates for SodaStream's growth are comparable to those of Green Mountain, but SodaStream has consistently beat estimates quarter after quarter. That means that current expectations could be too low, and SodaStream will probably offer more growth going forward than Green Mountain.
SodaStream shares have been volatile in the past year or so, but not as volatile as Green Mountain. SodaStream is looking to rapidly expand its business over the next few years, both in terms of increasing production through a new factory and expanding its US and global presence. SodaStream proved itself again last quarter, and if I had to choose one or the other, I would go with SodaStream, not Green Mountain.
Conclusion: Large issues remain, buying into an extended rally is not always the best idea
Green Mountain shares have rallied hard because of the buyback, not because the company is doing better. In fact, all of the guidance it recently gave was below expectations.
Shares closed Wednesday at $25.51, up approximately 67% from that after-hours post earnings low. That's quite a large rally, especially when growth forecasts have gone down since then. For investors looking at the name now, but not already in, they've missed a huge rally. For Green Mountain to rally another 67%, it would have to get to nearly $43. I don't see that happening anytime soon, even if it reports a good quarter coming up.
We did start to see some of the rally fade on Wednesday. Shares hit an intra-day high of $26.66 before losing more than a dollar. I'm not a fan at current levels because I think the company will lower its growth forecast again, meaning that the current fiscal 2013 estimates are too high in my opinion. I'm also not a fan of this buyback just because it doesn't seem the company has the money for it, it's doing it instead of spending on capital expenditures to grow the business, and it will hide the true growth of the company. If Green Mountain warns again when it reports next quarter, shares will plummet again.