By Jeff McAllister
Let me ask you a question or two. If your favorite cereal was copied and marketed as a lower-cost generic, would you buy it if it didn't taste quite as good? Or, would you spend the small difference to buy what you really wanted?
Another question: are individuals and companies able to learn, develop, and grow? In other words – evolve? Or, are they doomed to maintain their status quo? It's a ridiculous question, for if the answer were that the status quo will always be maintained then there would never be improvement. There would be no innovation. Everything would be exactly as it is now.
Such is the basic hypothesis that the bears have been touting as the ultimate demise of Green Mountain Coffee Roasters (GMCR). It's true that Green Mountain has had several significant issues over the past two years. Most of those issues, but not all, can be attributed to the fast-paced growth that Green Mountain experienced in its first few years. Some of the mistakes were foolish and some were due to simple inexperience. But to forecast that the condition and decisions of the company going forward will mimic those of the past would suggest that we do not learn from our own mistakes. Or, more to the point, they haven’t.
Similar to a child's growth, good judgment comes from learning from one's experience and past mistakes. Last night, Larry Blandford and Green Mountain Coffee Roasters demonstrated that they are moving from adolescence into adulthood.
On August 1, 2012, after the markets had closed, Green Mountain held its quarterly conference call. The numbers reported, while not inspiring, were in line with expectations. Topline growth was still around 20% and bottom line growth (i.e. earnings-per-share) were up 25%. But it's not the numbers that the analysts were concerned about. It was the discussion about how Green Mountain was going to react and position itself to the challenges it faces going forward. Those challenges consist of things such as patents expiring, inventory levels, accurately forecasting sales levels and most importantly, accounting procedures.
During the question-and-answer period of the conference call, analysts wanted to know what steps Green Mountain is taking to protect its market share as two of its patents are expiring, making it possible for competitors to flood the market with their own coffee products. The response was well thought out and logical. Green Mountain has long-term licensing agreements with most of the big names in coffee: Starbucks (SBUX); Dunkin' Donuts (DNKN); Caribou Coffees (CBOU); Newman's Own; as well as many others. The argument that consumers will abandon their Starbucks coffee for a no-name generic at Kroger or Safeway simply suggests that the commentator doesn't know the market. For if that were the case then why would anyone go to Starbucks to begin with? It's an expensive cup of coffee.
The fact is people will make buying decisions based on what they like. It's been proven over and over again that brand loyalty is more significant than minor price deviations. Do you really think that Mercedes-Benz became greatly concerned when Kia introduced its own flagship sedan?
Green Mountain did recognize that there will be additional competitors on the shelves in the market. They also indicated that they think that that might amount to about 15% correction. This dilution of market share was factored in to the forecasts for the rest of this year as well as 2013. Forecast growth is now in an area that is much more reasonable in the 15 to 20% range. A value that most analysts would agree is realistic.
Rather than recap the conference call, you can go and listen to it here. It's an interesting conference call and one that took many analysts by surprise. For the first time in several years it seemed to the audience that Green Mountain Coffee Roasters was taking a very serious look at exactly what its strengths and weaknesses are, and how they are going to maximize their strengths and address their weaknesses. As I write, Green Mountain Coffee Roasters is up almost 30% on significant volume. At this price and with the P/E ratio of 11.3, I maintain the Green Mountain Coffee Roasters is undervalued. Not significantly, but I think that a fair price based on its earnings puts Green Mountain coffee roasters at about $35 per share.
Bears, you've had your day. You made your point. But playtime is over, and Green Mountain Coffee Roasters has just grown up.
Disclosure: I am long-time Green Mountain coffee roasters investor.