Green Mountain Coffee Roasters (Nasdaq: GMCR)
started selling its single-cup coffee brewing systems (known as the
Keurig) five years ago, few expected the company to single-handedly
revolutionize the coffee industry.
These days, former rivals are looking to partner with the company
to help get a piece of the fast-growing "K-Cup" market. And because
Green Mountain Coffee licenses its technology and rolls out its own
expanded level of brewing options, sales and profits continue to
grow at a breakneck pace. After rising at least 40% in each of the
past five years, sales are expected to double to $2.7 billion in
that ends in September. That's impressive.
What's less impressive is Green Mountain Coffee's $15 billion
, which puts the stock's value at more than 50 times projected
fiscal 2011 profits. You have to question the wisdom of owning such
a richly-priced stock in these sobering times. It would also be
foolish to short the stock, simply because the company is unlikely
to see sales slow in coming quarters.
But it's easy tospot a pair of stocks to short in this hot sector,
simply because these companies are sporting lofty multiples even
though they aren't really high-growth stocks. I'm talking about
Caribou Coffee (Nasdaq: CBOU)
Peet's Coffee (Nasdaq: PEET)
. These coffee chains, which have long toiled in the shadow of
Starbucks (Nasdaq: SBUX)
, are embarking on store expansions intended to deliver decent
growth in the near-term, yet look to be very modest growers in the
long haul. There's simply no good reason why
of each company deserve a price-to-earnings (P/E) multiple (on
projected 2011 profits) approaching 40. Let me explain...
This chain has its roots in the Midwest, with more than half of its
almost 500 stores in Minnesota, Illinois and Ohio. With a handful
of stores in 13 other states, Caribou has always lacked thecritical
mass in those markets to help cover advertising and distribution
costs. This lack of scale kept Caribou from generating any
from 2003 through 2008. But in the past two years, the coffee chain
has moved modestly into the black as a result of its expansion in
several markets, which finally pushed the company over the
Caribou is also benefiting from a push into supermarket
distribution, which helped sales rise 16.5% in the second quarter
to $80 million. A big chunk of this comes from supermarket sales,
and because stores already carry a huge selection of brands, it may
be hard for new products to gain traction. So it's unclear whether
management will be able to double the base of supermarket sales in
the next few years, as some analysts forecast.
For this matter, it's not clear that we even need more
coffeehouses. Starbucks did a fine job of blanketing the nation
with a coffeehouse in virtually every key retail location. Caribou
will most likely have to settle for second-tier locations as it
rolls out more stores.The company expects to open 10 new locations
in the 2011 fiscal year, and plans to add 8-10% to its store base
by the 2013 fiscal year.
But the stock's real problem lies in Caribou's expense structure.
Coffee prices are surging, pushing Caribou's gross margins down
nearly 3 percentage points in the most recent quarter, compared
with the year-ago period. Therefore, unless coffee prices fall
back, Caribou's year-over-year profit growth rates are set to slow.
Profits in the first half of 2011 doubled to $7.4 million, but
second-half profits are expected to rise only 10%. Caribou is on
track for respectable growth again in fiscal 2012, with profits
expected to rise roughly 20% as the company opens more stores and
has the benefit of a full year's worth of distribution with grocer
Publix. In addition, Caribou plans to ramp up its K-Cup offering, a
venture that's new to the company and still generates minimal
Caribou is still likely to be a distant third in the coffeehouse
space and is surely displeased to see a revamped Starbucks back on
the growth path. In this light, you have to question why shares
have doubled in the past six months, and how investors can justify
the P/E multiple of 31 times projected 2011 profits.
This West Coast chain has a better track record than Caribou. Sales
have been rising at a moderate pace throughout the past decade and
the company has been consistently profitable. The financial
performance is all the more impressive when you consider Peet's
operates only 193 stores, a number that would usually be considered
too low to gain
in terms of advertising and distribution.
Just like Caribou, Peet's is pushing to expand into supermarket
distribution as a way to boost sales. The company's coffee
varieties have a great reputation among coffee connoisseurs, which
has helped Peet's garner premium pricing (its coffee can fetch
upwards $10 a pound, while many supermarket brands sell for half as
much). Trouble is, Peet's has only really proven itself in
California, Oregon and Washington, an area known for coffee
fanatics. As the company looks to build its brand, it's going to
find saturated markets and more price-sensitive customers.
And pricing is crucial in this business because these companies
must find a way to offset ever-rising coffee prices. Peet's coffee
costs (per pound) rose 37% in the second quarter. As a result,
profits are likely to dip in the third and fourth quarter compared
with year-ago results. Despite profit pressures, investors have
been pouring into this stock, hoping to catch the next Green
Mountain-like winner. The stock has been up about 33% in the past
six months, but with shares trading for more than 30 times next
year's profits, a clear disconnect has emerged.
As a final concern,
Dunkin Brands (Nasdaq: DNKN)
, which went public on July 27 and operates about 9,800 stores, is
looking to sharply expand its base of Dunkin Donuts coffee shops in
the Western region of the country. This chain has much more
financial firepower and the resources to spend heavily on
advertising. That's a Goliath that Peet's and Caribou are
unlikely to topple.
Action to Take -->
When investors start to realize growth prospects will dim beyond
2012, they're going to start to question these high P/E coffee
retailers. Coffee stocks have been on a tear this year, but
investors should soon realize that Starbucks and Dunkin Brands have
already saturated this space. Peet's and Caribou Coffee appear
by at least 25% to 30% -- if not more. If you own either of these
stocks, you should consider getting out before short-sellers catch
-- David Sterman
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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