Green Mountain Won't Bottom Until Expectations Come Down

| About: Keurig Green (GMCR)
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Shares of Green Mountain Coffee Roasters (NASDAQ:GMCR) had a bad ending to 2011 after notable hedge fund investor David Einhorn gave a presentation on the stock on why he was short, and then the company had a huge revenue miss with its fiscal fourth quarter earnings.

I defended the stock when Einhorn came out with his presentation, but after the company missed by a wide margin on revenues last quarter, I changed my opinion. As their fiscal first quarter has just ended, I've decided that it is time again to take a look at where they stand. I am short the name in my theoretical short portfolio for this site, but I do plan on covering that position on the next big down move.

With Green Mountain shares closing Wednesday at $45.34, I've decided to analyze whether this could be a good buying opportunity for the stock. The stock did fall into the mid and upper $30s after that bad earnings report, but the stock rallied back to $60 in early December. After looking at some numbers, my personal opinion is that we have not seen a bottom yet, as first quarter expectations are too high currently and that could lead to another big miss for the company.

Let's look at the numbers. The following are the year over year growth numbers for the company's fiscal first quarter in the past three years.

Growth 1Q 2009 1Q 2010 1Q 2011
Revenues 77.36% -1.21% 66.60%

Now, the company has finished some acquisitions over the past couple of years, but the current estimate for sales this quarter is $1.06 billion. That equates to 84.6% growth, a number larger than any of the past three years, and remember, we are starting with a higher base number ($575 million). The company last quarter was projected for about $760 million, and came in at $712 million. That's a wide miss. It could certainly happen again. That sales miss last quarter caused the huge selloff in the stock.

Despite the huge revenue miss, Green Mountain only missed earnings per share estimates by one penny. However, they had beaten by an average of 25% in the prior three quarters. The problem is that Green Mountain's fiscal first quarter is the company's worst quarter in terms of margins, as you can see from looking at last year's numbers.

Margins 1Q 2011 2Q 2011 3Q 2011 4Q 2011
Gross 25.11% 37.50% 36.82% 35.69%
Operating 4.01% 18.47% 16.64% 14.99%
Net 0.39% 10.09% 7.86% 10.59%

There is even worse news. Over the past few years, their first quarter margins have come down each year. Look at the following:

Margins 1Q 2008 1Q 2009 1Q 2010 1Q 2011
Gross 27.08% 29.15% 27.69% 25.11%
Operating 12.67% 6.60% 5.51% 4.01%
Net 7.30% 3.58% 2.91% 0.39%

Based on current revenue and earnings per share estimates, analysts are looking for about 5.5% in net margins this quarter. That's significantly higher than each of the past three years, and the company has had trouble beating that number in terms of operating margins. It is possible that a scenario like last quarter (earnings in line, big revenue miss) could produce a higher than expected net margin, but if that's due to a bad revenue number, the margin number won't exactly be viewed in high regard. The stock will drop.

Why am I so bearish on this quarter's sales? Well, every store I visited during the holiday season had tons of k-cup displays, but there didn't seem to be many units being sold. Green Mountain has had a huge increase in its inventory balance lately, and I don't think they were just stocking up for the holidays. Look at the following chart, which shows their inventory balance as a percent of current and total assets at the end of their fiscal fourth quarter (going into holiday season):

Inventory 2009 2010 2011
Current 24.59% 53.00% 59.41%
Total 16.25% 19.15% 21.02%

Just in the past four quarters, the company's inventory balance has risen from $262 million to $672 million. That's a lot of inventory. With so much inventory out there, the company may be forced to reduce prices, which will eat into their margins, and lead to those disappointing sales numbers that I think you will see.

Green Mountain did enter an agreement with Starbucks (NASDAQ:SBUX) in the past year, and that has helped it to further expand its product offering. However, they have patents coming off into late 2012 for their K-cups, so they will need to figure out a way to hold off the competition. I've now seen Dunkin Brands (NASDAQ:DNKN) advertising their K-cups in TV commercials, so Green Mountain is in for a new challenge, if they don't have enough on their plate already.

Anyone thinking that Green Mountain shares have hit a bottom may be in for a surprise when the company reports on their latest quarter. While they may do well on the bottom line, and have had no trouble over the years beating analyst earning per share estimates, the future of the stock will depend more on the revenue number.

Given the fact that current estimates call for 85%, I think a miss is quite possible. Holiday sales most likely have been so-so, especially with all of the warm weather. Add in the huge inventory numbers and they will be forced to mark down their prices. Green Mountain shares may soon find a bottom, but it won't be until expectations come down. Right now, they are just too high for my liking. The short case is still in tact.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.