Robert D.'s  Instablog

Being from the Northeast (top market for coffee producers), I do enjoy one or two cups of coffee a day. I am not the kind of person that puts much thought into the coffee I'm drinking, but suddenly I have been flooded with choices. Major stores now have full isles of coffee selections. A new trend of instant coffee is underway, and while some people may have seen this in their offices (Flavia has cornered this market), not many have switched to the coffee-pods at home. Until recently that is, as Green Mountain Coffee (once just a penny stock on the OTC), has now over taken major stores with their kpod machine and pods, targeting at-home customers. These pods, costing around $0.50 each, have now become an incredible hit. Allowing the consumer to store in their homes, 20 different kinds of coffee and teas in pods, so that each individual person can have their own personal cup of coffee, is now becoming the norm.

These pods generate an 8oz cup (soon 12oz pods coming), and come in a wide variety of flavors and strengths. The company has been generating an average sales growth rate of 56% over the past 12 quarters. During their most recent quarter release, GMCR posted a 97% net sales increase on their Keurig (k-pods) business, as well as a 39% increase on their Specialty Coffee business.

From their earnings call:

"The primary driver of the increase in net sales is the continued growth in K-Cup sales which were up over 79% on a  consolidated basis. Sales related to the Tully's brand represented approximately 5.5% of the 61% increase in  consolidated net sales and are included in the Specialty Coffee business unit results for the first time.

Excluding the Kraft litigation settlement, we now expect fully diluted non-GAAP EPS in the range of $1.10 to $1.14  per share, up from prior estimates of $0.98 to $1.02 per share."

Their optimism has without a doubt made shareholders very happy, giving them incredible returns over the past few years. They continue to raise their expected EPS, and have also given very optimistic targets for 2010:

"Our outlook for fiscal 2010 anticipates a net sales growth rate of 45% to 50%, shipments of system wide K-Cup  portion packs to increase in the range of 65% to 70% and fully diluted GAAP EPS to be in the range of $1.70 to $1.80  per share."
 

The company sells its products over major outlets, such as Bed Bath and Beyond, Kohl's, Target, and now Wal Mart. Coffee drinkers have become intrigued by this new technology (convenience of disposable packets), and variety (many flavors), that this is actually pushing consumers to invest in these $99 coffee machines that use these $0.50 pods.

Now let's look at a comparison of current key valuations between three major (public) coffee players, Starbucks, Green Mountain and Diedrich.



Investors are clearly building a large short position on GMCR. Their explosive growth has pushed the stock price beyond reasonable valuations pushing their PE multiple to extremes, and is now trading at 14 times book value. Starbucks has generally received a premium on their shares, being an innovator in its business, and being one of the most successful coffee shops of this decade. GMCR may be sporting this same premium at the moment.

I am very confident that GMCR will continue on its path of growth, however I am very hesitant to invest in a company which bolsters their high EPS targets after 12 quarters of incredible growth. Any earnings miss, could cause this stock to follow in the footsteps of companies like CROX or HANS.

As call option activity continues to rise at the $80 level for October, it seems people continue to expect this stock to push higher. Their next two quarters may be their best ones yet, and shares may continue to rise, however I will sit back with a cup of coffee and wait for the shares to come down to more reasonable valuations, or begin to slowly build an OTM put-option position for the long-term. Expect high volatility coming near or on earnings.

Disclosure: I do not hold any stocks mentioned at the time this article was written.