Investors of Green Mountain Coffee Roasters (GMCR) have had a rocky road in 2012 as shares have tumbled for much of the year. Fortunately, shares have recently bottomed during the last quarterly conference call and have marched back above $25 a share. What investors really want to know is will there be another "shoe to drop" or will they be rewarded for sticking with such volatility over the last several quarters? If one is to take a quick peek at the 11 times earnings multiple, it seems like an awfully cheap stock, but due diligence is much more than looking at a low price to earnings multiple; it's researching why the multiple is so low.
In this article, readers and investors are going to see some firsts. That's right, some never before seen information that is highly sought after in the consumer goods and retail industry. Secondly, in this article, I aim to answer some of those questions posed by Ben Strubel in his last article titled "Green Mountain Coffee Roasters Management's Comments About Inventory Don't Add Up" by offering some analysis via another article written on Seeking Alpha by Peter Mycroft Psaras titled "Wal-Mart: The Perfect Indicator For A Strong Economy." With regards to both of these articles, which are presented in a very clear and concise manner, they simply don't answer questions that a GMCR investor may still have; they do offer possibilities and further contemplation, however.
So let's talk about GMCR's inventory issues if we are to call them issues. The fact is that if you are taking markdowns and write downs on your products, there is a problem with operations and analyzing sales trends. Investors can't argue this very simple fact that Bill Strubel outlines for readers and investors with detailed information taken from quarterly releases and management's conference calls. Additionally, investors can't deny that during the latest quarterly conference call, management admitted that they are using a new methodology for forecasting sales and business trends, indicating that in the past, the company's formula for forecasting had not proven itself to be effective. So here is the most important question, "Who is to blame? GMCR?" Well, that is the question we hope to advance in this article.
GMCR is in a tricky spot to be in as the leading producer in the single-serve coffee and flavored coffee drinks category. Why is this you might be asking yourself? Being the leader often places a spotlight on oneself, and thus it attracts a lot of attention, both good and bad. GMCR's Keurig platform is the leading product segment at Bed Bath & Beyond (BBBY), and BBBY is the leader in Keurig sales. I bet you thought Wal-Mart (WMT) sold the most Keurig products. The fact is that during the first three quarters of the year, Wal-Mart only sells slightly more Keurig products, but come 4th quarter, BBBY supersedes Wal-Mart sales and by a pretty wide margin, making them the leading sales producer for Keurig products on an annual basis. Now you're probably asking yourself how a company like Bed Bath & Beyond with only 1,000 stores in the U.S. and Canada combined can sell more than Wal-Mart, which has more than 4,800 stores in the U.S. and Canada.
When consumers think about buying kitchen electrics, they typically think about Bed Bath & Beyond, not Wal-Mart, as their selection is not as expansive as BBBY's. They also recognize that BBBY's customer service is usually much more complementary than that of WMT's and their staff usually knows more about the individual products. Just a notable fact since we aim to deliver supportive factual information. BBBY carries over 80 K-Cup flavored coffee SKUs, while WMT carries less than 50 of these SKUs.
If you need any more proof of the imposing power that BBBY has when it comes to kitchen electric sales, GMCR dedicated the launch of the new Vue brewing platform to BBBY and not to WMT for the aforementioned reasons. If you're talking GMCR, you're talking about kitchen electrics, and if you're talking about kitchen electrics, you're talking about BBBY. They simply have an eye for what sells in this category and have been a leader for years. Furthermore, BBBY will dedicate sizeable orders for products that not only sell well in stores, but which also advance the branded appearance of the BBBY stores. Look up the next time you go into a BBBY store. Notice those blocked-out spaces with boxed products above the displays and out of reach, those are what BBBY refers to as windows. If the product you like or want to buy is in these windows, trust that it is selling well and has been heavily ordered by the company. You might also want to look at BBBY's top-stock, which is at the very top of the company's store fixtures and usually in their respective departments. So now that we fully understand which retailer is GMCR's biggest retail partner and we understand some of BBBY's merchandising strategies, let's move on from here.
Sometimes, manufacturers have issues with selling to BBBY. What I mean by this is that orders from BBBY can be skewed from quarter-to-quarter and year-over-year depending on new product releases and a particular product catching on at their retail stores and then other retailers. BBBY first started selling Keurig products in 2003, bought into the product line heavily and almost single handedly advanced the new product segment before other retailers took notice and began selling the products themselves. This forced BBBY to adjust their forecast for sales of Keurig products, which also forced them to adjust their orders of Keurig products.
When BBBY believes in a product, it really goes after it. For example, look at what BBBY did for SodaStream (SODA) back in 2010. Now, almost every major department store retailer carries SodaStream products and it all started with BBBY. Last Christmas, BBBY dedicated its Christmas circular's cover page to the Soda Stream soda machine. The company ordered heavily into this product, and skewed the quarter-to-quarter numbers for which SODA attempted to forecast. This is the BBBY way as it puts the full force of their advertising and shelf space behind products it believes in. Unfortunately, new products come out all the time and the orders BBBY provided your company in the past may not prove to be the same in the future.
So what happened to Keurig orders through BBBY recently? We make no excuses for GMCR when it comes to forecasting, the fact is the company should have had enough experience with its retail partner to understand when and to what extent BBBY would be ordering. Our channel checks from BBBY showed large on orders and build to for the majority of Keurig SKUs in the 4th quarter of 2011, which is the 1st quarter for GMCR. Obviously, this increase in ordering from Bed Bath & Beyond resulted in strong revenues for GMCR when it reported Q4 earnings. Shares of GMCR rocketed higher when GMCR reported earnings that day, but many wondered why it did not increase guidance after such a large beat on earnings, and I think you can see why now. Since Q1 of 2012, orders from BBBY to GMCR have slowed in order to include the newer SKUs from Starbucks K-Cups and as it began to work off existing inventory through Q4 2011 and Q1 2012. It is also a safe bet that the company reduced on hand levels of Keurig brewers over this time and likely continued to issue more conservative brewer orders ahead of the launch of the Vue system and as it created orders for the CBTL brewer system and Nespresso's new line of single serve brewers.
While investors may not initially buy these orders as proof or an explanation for GMCR's slowing sales trends and increased inventories, the data is in black and white and does not lie. The only way data can lie is through the interpretation of the data. The bottom line is that GMCR did not adjust its production to fall more in-line with orders produced by its number one retail partner. This is not to suggest that BBBY was the only retail partner issuing smaller orders. Kohl's (KSS), JC Penney (JCP) and Macy's (M) issued smaller orders over the last two quarters based on channel checks we have seen.
There is a direct correlation between the short activity ahead of recent earnings announcements from GMCR and the channel checks for which the large institutions have access to. In this article, we plan to show you an example of what the institutional traders see that most retail investors don't get to see. It is time to level the playing field investors. There is a common misconception about channel checks. Some people think they are illegal, some think it is just going into a store and counting items on a shelf or talking to a manager. First and foremost, channel checks are not only legal but encouraged by the financial community as they are a source of information that can better detail the intra-quarter dealings for a particular company. What is illegal is achieving channel checks through the misappropriation of data (channel checks should not be achieved through fraudulent measures). The problem with obtaining channel checks for a particular item is getting a large enough sample size to determine trends and efficacy of the data. Most retail investors can't afford to purchase large scale channel checks and are very dependent upon intra-quarter announcements and quarterly results for sales updates. There are very few institutions that offer large scale channel checks and they usually only do so for major corporations, large hedge funds and institutional funds. We are trying to change this reality to benefit the retail investor.
When GMCR stated that it didn't expect to see any meaningful contribution to earnings from the Vue platform, it made a wise statement. We have been conducting channel checks on the Vue system since it first launched earlier this year. There was a strong initial consumer read that we saw during the first month of availability at Bed Bath & Beyond. In a research note to clients, we offered the following in February 2012:
"The current On Hand totals of Vue machines as of 4/16/2012 for Bed Bath and Beyond is 8,436 units. In the last 4 weeks, 4,906 units have been sold. In the last 8 weeks, 7,221 units have been sold. The On Order Total is 12,792, which when combined with the On Hand total, represents an inventory level with a run-rate of roughly 10 weeks."
Since the time we released this research note to clients, the Vue has rolled out to several additional retailers such as Dillard's, Macy's, Wal-Mart and Kohl's. Since the inception of the Vue at retail distributors, sales have been steady month-to-month excluding June which marked Mother's Day and Father's Day holidays. Until greater varieties of V-packs are made available we may not see more positive results. Additionally, we expect a price reduction on the Vue in the future. Amazon.com has already reduced the price for the Vue brewer, which is now on the home page.
The questions investors should be asking themselves at this time is if there is a price ceiling which current Keurig users and potential Keurig users are willing to spend for a cup of coffee. Is it a matter of the state of the economy and the squeezing of the middle class forcing the consumer into lower-end brewer systems? The tell is in the channel checks. Having made the points of interests above, what we can clearly say is with regards to inventory, GMCR has dedicated a large portion of production to brewers, including the Vue system, so it may need to demonstrate a more value-added pricing structure for these brewers to increase the Keurig user base during slower economic conditions.
There doesn't seem to be too much help on the way for GMCR through BBBY. With the success it saw in brewer sales last year, BBBY is ordering early this third quarter. However, based on our channel checks, orders look to be slightly lower than a year ago the same period. The only question left is whether or not GMCR will be able to work off its inventory of finished goods and contain manufacturing costs in the quarter by utilizing its new forecasting methodology. This is a big question for investors to consider as holiday preparedness orders from other retailers will likely commence during September.
Without any further ado, we will issue a channel check recently received from a GMCR retail partner in North America. Feel free to click on the following link which will land you on a page view of the Vue brewer and instructions on how to read the channel check. When analyzing a particular channel check it is important to have all the supporting information such as duration of SKU, retail distribution of SKU, projected retail distribution of SKU, seasonality of SKU, last year comparison if applicable and competition for SKU. Without these additional pieces of information, channel checks are deemed raw data and sometimes fail to be value added. Having said that, without these additional pieces of information, one will still be able to determine the trend of sales for a particular SKU which is a good indicator for quarterly trends.
It really is all up to GMCR management and their ability to forecast sales going forward; they have plenty of inventories to work-off as purchase orders come in this quarter. If they save money by effectively managing inventory over the next couple of quarters, they can increase efforts elsewhere or simply bank those savings to drive earnings results. This banking may not work though as investors, especially short speculators that will probably focus on revenue growth as the sign of what is to come for GMCR in the future.
GMCR has even more competition than ever. The threat from private label brands is ever-increasing and CBTL is gaining retail exposure by the quarter. Nespresso recently launched new single serve brewers called Pixie and U, which are now available at both Bed Bath & Beyond and Williams Sonoma (WSM). We can't forget about a more closely related competitor to Keurig which is the Tassimo. Braun recently came out with the new Tassimo T55 and it can be purchased at Bed Bath & Beyond also. Remember, when Bed Bath & Beyond believes in a product, it supports it with shelf space and orders. Williams Sonoma discontinued its distribution relationship with GMCR when GMCR began selling Keurig products at Wal-Mart. Manage those inventories GMCR, you have other fish to fry…quickly.
Disclosure: I am long SODA.