Green Mountain: Too Far, Too Fast

| About: Keurig Green (GMCR)
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After the bell on Wednesday, shares of Green Mountain Coffee Roasters (NASDAQ:GMCR) took a hit after the company's fiscal first quarter earnings release. While the company beat slightly on revenues and crushed earnings, Q2 revenue guidance was light, and there were some other red flags. For a stock that had rallied from $15 to $49 over the past six months, Green Mountain failed to impress. This was simply a case of a stock rising too far, too fast. After the results Wednesday, the Green Mountain short case seems to be back.

First Quarter results:

Green Mountain reported revenues of $1.339 billion, slightly ahead of the $1.33 billion expected. Non-GAAP earnings per share came in at $0.76, well ahead of the $0.65 that was expected. The 15.6% rise in revenues did miss the company's guidance midpoint, however, as they were expecting 14% to 18% growth.

The GAAP results don't look as impressive, because of the huge gain the company recorded on its Filterfresh sale last year. GAAP net income only rose by 3.12%, compared to the 15.6% rise in quarterly revenues. The company did see an increase in gross margin from 29.06% to 31.3%. The following table provided by the company details what helped and hurt gross margins during the period.

If you take out the benefits from the reduction in green coffee costs, gross margins would have declined. Thus, going forward, any spike in coffee prices could hit gross margins, as the company is not increasing them consistently. Also, they were helped tremendously by items being less bad, like the warranty expense and sales returns. Additionally, despite the 224 basis point rise in gross margins, operating margins only rose by 103 basis points. Green Mountain saw sharp rises in selling costs (21.57%) and general costs (31.31%) over the prior year period. Overall, operating expenses rose 24.09% from the year ago period.

Further down the income statement is where things get distorted by the Filterfresh gain. Overall, the net profit margin declined from 9.04% to 8.06%, but the year ago period had the increased margin due to the one-time gain. Green Mountain's tax rate also rose from 37.66% to 38.43%, which again was partially due to the prior year sale.


This is where the company struggled a bit. For the fiscal second quarter, the company stated that it expects revenues to increase by 14% to 18%. However, the street was looking for 20.2% growth. The company's midpoint is well below what the street was expecting, and this is not a good sign. On an earnings per share front, the company guided to a range of $0.70 to $0.75 for non-GAAP earnings. The midpoint of that range is slightly below the $0.73 that analysts were looking for.

For the fiscal year, the company maintained its forecast for 15% to 20% revenue growth. That remains ahead of the 16.6% growth analysts were looking for entering the Q1 report. On an earnings per share basis, the company raised its forecast. The old forecast was for $2.64 to $2.74, while the new forecast is for $2.72 to $2.82. This could be seen as a slight negative, because they raised their forecast by 8 cents after an 11.5 cent beat in Q1. That means that future quarters may not be as rosy, as they are essentially taking down Q2 to Q4 guidance from $2.045 to $2.01 (based on the midpoint of each range).

The company also reaffirmed its guidance for free cash flow of $100 million to $150 million. However, Q1 free cash flow was $254 million. The company expects positive free cash flow in Q2, meaning Q3 and Q4 should see negative free cash flow as they build up inventories for next year's holiday season.

Finally, the company again cut its capital expenditure forecast. The old range was for $380 million to $430 million. They now expect just $350 million to $400 million. If you remember my prior article, I mentioned how in the previous fiscal year, they ended up with about $450 million in capex after originally forecasting between $700 million to $780 million. They are not investing in their future.

Examining Free Cash Flow:

The company boasted that it produced $254 million of free cash flow during the quarter. That was much larger than the $30 million produced in last year's Q1. However, when you break down the numbers, it is easy to see why there was such a difference.

  • $18.39 million less in capital expenditures. They are cutting capex to make cash flow look better.
  • $18.2 million more in depreciation add-backs.
  • $51.35 million more in increased accrued expenses. Accrued expenses are a current liability. By these liabilities increasing, cash flow increases until they are paid off.
  • $112.7 more in inventory cuts. Green Mountain didn't replenish as much inventory this quarter. While this is good in the sense that they've been criticized for holding too much inventory, it is now inflating cash flow numbers.

There are several other items that go into the company's cash flow numbers, but I wanted to point out those four in particular. By cutting capital expenditures, not holding as much inventory, having higher accrued expenses, and more depreciation, the company can artificially inflate cash flow numbers. Given that their full year forecast for free cash flow is well below that of the Q1 number, we'll see those numbers reverse in the next few quarters.

The buyback:

The company is in the process of a $500 million dollar share repurchase program. During the quarter, the company repurchased 4.3 million shares. However, they really didn't repurchase any more shares. What do I mean? Well, they told us on the Q4 conference call that they had purchased 4.3 million shares already in the quarter.

So between November 27th and January 31st (the date their guidance is based off of), the company didn't buy back any shares. On November 27th, the stock closed at $28.95. The next day, the day after earnings, it closed at $36.86. If they weren't buying back shares at $37 to $40 earlier in the quarter, do you expect them to buy them back at $45 to $50 now? Shares closed at $48.94 on Wednesday.

Shares falling on the report:

Right at around 4pm on Wednesday, shares initially bounced higher to almost $54. My guess is that some got the headline numbers and started buying. However, once the report was digested, including the subpar guidance, shares started to decline. Shares extended the extended hour session down $3.44, or 7.03%.

So why did shares decline on the news? Here are my top reasons why:

  1. Poor Q2 revenue guidance and so-so earnings guidance.
  2. Q1 revenues beat, but missed company's guidance midpoint and investors seemed to want more.
  3. Free cash flow not as positive as it seems.
  4. No additional shares bought back.
  5. The stock had run from $15. Expectations were high, and thus, profits were taken on a good, not great report.

Why the short case may be back:

Green Mountain didn't do enough on Wednesday to get rid of the non-believers. The poor Q2 guidance will definitely fuel those arguing that the patent expiration last September is opening the company up to more competition. Analysts were expecting more than 20% growth, and that was down from last year's Q2 revenue growth of 37%. Green Mountain giving a much lower range is not positive.

Basically, you have a company that is seeing slowing revenue growth, is not really expanding margins, and has almost no cash. The company's cash flow number was misleading in Q1, and they are cutting capital expenditures by the quarter, most likely to free up funds for the buyback. The company needs to invest in itself for the future, and they are not doing it right now. Eventually, they will need to, especially when it comes to international growth.

It's hard to value a company like Green Mountain, because you are essentially going quarter to quarter with a momentum name like this. Green Mountain needs to consistently beat expectations for shares to continue higher, and Wednesday's report was disappointing. For that reason, I think shares will track lower over the next couple of weeks. For those worried about slowing growth and poor cash flow, the short case is back, and Green Mountain will have to wait another few months to chase the bears away.

Remember, after the company's Q3 report back in August, shares traded just above the $15 level in after-hours. Those shares traded for about $54 early Wednesday afternoon. When a stock rallies like that, expectations are high, and Green Mountain needed to justify that rally. It didn't on Wednesday, which is why shares have come down to $45, and I wouldn't be surprised if we head closer to $40. We can re-evaluate the name again there.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in GMCR over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.