Green Mountain Coffee Roasters (GMCR) is among the largest specialty coffee producers in the U.S. Its founder, Robert Stiller, became a billionaire after the company announced its strategic collaboration with Starbucks (SBUX). Instantly, the stock moved up by almost 45%, in March. Since then, the stock kept going higher and higher until the last month. It tested its $110 resistance twice and literally collapsed after David Einhorn’s bearish comments at the value investment conference.
As of October 27, GMCR was trading at $61, with a 52-week range of $29.55 - $115.98. It has a market cap of $9.43 billion. Trailing twelve month (ttm) P/E ratio is 60.38, and forward P/E ratio is 23.51. P/B, P/S, and P/CF ratios stand at 5.19, 4.08, and 123.84, respectively. The 3-year annualized revenue and EPS growth stand at 58.4% and 71.2%, respectively. Operating margin is 13.1%, and net profit margin is 6.5%. The company does not have much debt. Debt-to-equity ratio of 0.2 is well below the market average of 1.1. GMCR does not pay any dividends.
GMCR has been a Wall Street darling since 2007. It has always been trading with high multiples. The company has a 5-year average P/E ratio of 59.9. Out of 11 analysts covering the company, 9 have buy, 1 has hold, and 1 has sell ratings. Wall Street has diverse opinions on GMCR’s future. The bottom line is 45.1% growth, whereas the top-line growth estimate is 70.7% for the next year. Average five-year annualized growth forecast estimate is 37%.
What is the fair value of GMCR, given the forecast estimates? We can estimate GMCR’s fair value using discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS of $1.02 along with the mean EPS estimate of $2.62 for the next year. (Finviz)
E0 = EPS = ($1.02 + $2.62) / 2 = $1.82
Wall Street holds diversified opinions on the company’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 37% (Morningstar). Book value per share is $11.87
The rest is as follows:
Fair Value Estimator | ||
V (t=0) | E0 | $1.82 |
V (t=1) | E0 (1+g)/(1+r) | $2.25 |
V (t=2) | E0((1+g)/(1+r))2 | $2.77 |
V (t=3) | E0((1+g)/(1+r))3 | $3.42 |
V (t=4) | E0((1+g)/(1+r))4 | $4.22 |
V (t=5) | E0((1+g)/(1+r))5 | $5.21 |
Disposal Value | E0(1+g)5/[r(1+r)5] | $47.39 |
Book Value | BV | $11.87 |
Fair Value Range | Lower Boundary | $67.08 |
Upper Boundary | $78.95 | |
Minimum Potential | 8.93% | |
Maximum Potential | 28.20% |
(You can download FED+ Fair Value Estimator here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for GMCR is between $67 and $79 per share. While GMCR lost 40% since the last month, it still has at least 8% upside potential to reach its fair value range. Moreover, the stock has up to 28% upside potential to reach the upper boundary of its fair-value range.
Summary
Looking at the chart above, one can see the huge gap between $42 - $58 range. Thus, if the sell-off keeps going on, the stock might go all the way down to close this gap. On the other hand, as Jim Cramer suggests, going long might be a good deal, when the shorts have to cover their positions.
Waterbury, Vermont-headquartered Green Coffee Mountain Roasters is one Cinderella story. The company offers the same coffee with a different taste, and in a more convenient form. That tiny difference in production/marketing process created a gigantic company. Its founder, Robert Stiller, put into sell 2 million shares, but he has not started selling his holdings yet. Apparently the stock looks too cheap to sell.
In the last 5 years, GMCR was able to increase its earnings per share at annual rate of 46%. The company is highly profitable with a gross margin of 33%, and net profit margin of 6.58%. GMCR’s O-Metrix score of 4.41 is slightly below the market average.
Analysts have very diverse opinion on GMCR. Their mean target price of $120 implies a lot of upside potential. Longbow has an upgraded target price of $112. While this target price seems to bullish, the stock looks like less-than fairly valued for 37% growth.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.