Are Shorts Right About Green Mountain?

02/27/2013 10:00 am EST


The stock has taken a wild ride recently, as the company barely survived a short attack, and David Mamos of Money Morning wonders whether it’s time to take a 'coffee break.'

Early investors in Green Mountain Coffee Roasters (GMCR) rode it all the way to $111 per share.

But in a ten-month period during 2011 and 2012, shares fell to $17, losing 85%. However, since the lows back in July 2012, the share price has risen over 150%, and is up over 80% from the November lows alone.
GMCR manufactures and sells the Keurig brewer and K-Cups, which are used with the Keurig to brew a single, premium cup of coffee. The single-serve packs accounted for nearly 65% of revenue ($863 million), and the brewers accounted for approximately 28% of revenue ($377 million) in the recently released first-quarter 2013 earnings report.

The K-Cups have been patent-protected. However a number of these patents have expired, leaving the door open for competitors to produce knockoff K-Cups that work with the Keurig brewer.
This last quarter was the first opportunity to see how well the K-Cups fared with this new competition. To the surprise of some, they did quite well, with sales increasing 19% over the prior-year period.

But it may be a little early to say that GMCR has a handle on this situation, since more competitors are gearing up to enter this niche market by the end of 2013. Walmart's (WMT) Café Escapes and Supervalu's (SVU) private-label brand are already on the shelves, and more are on their way.

Some argue that the competition will benefit GMCR, as other coffee pod formats will disappear and the K-Cup will become universal. This will naturally lead to more sales of the Keurig brewer.

But even if you assume this is so, there is also competition in the single-cup brewer market, especially from Starbucks (SBUX) and its Verismo brewer. Thus far, Verismo has not fared well in gaining any market share traction, due to its high price. But I wouldn't be so quick to dismiss a company like Starbucks, given its deep pockets and international appeal.

Even still, GMCR has been the dominant player in a now-mature North American brewer market. Further growth will need to come from overseas, which thus far has been limited. Meanwhile, Starbucks is well equipped to harness its vast popularity abroad, and preempt any attempt for GMCR to expand internationally.

The price of coffee as a commodity has fallen nearly 40% since last year. This large drop will come as an advantage to GMCR, as it works off the old, higher-priced beans in inventory and purchases new beans. This will already improve upon the K-Cup’s hefty profit margins.

Then there's the short interest. Famed short seller David Einhorn was almost single-handedly responsible for bringing down GMCR's share price from its all-time highs.

Einhorn's primary concern was GMCR's questionable accounting. Subsequently, the SEC did investigate GMCR, and some financial statements have been revised.

Since then, the share price has recovered. But as of last October, Einhorn still holds his short position, and is still extremely negative about GMCR's accounting. The short interest is large, standing at over 21% of total shares, while the short ratio is near 6.3.

On the other hand, GMCR stands on the opposite side, since it is in the midst of a $500 million share-repurchase program. Either the shorts will be rewarded if Einhorn is right about his analysis, or GMCR could be in for a substantial short-squeeze run as its business plan comes to fruition.
For me, these issues do not make for a good investment. Those holding the shares are simply "hoping" for good news out of the company that will trigger a short squeeze—or at the very least, they are "hoping" to be bought out by a larger player. That's why I am a seller of Green Mountain Coffee Roasters.

Read more from Money Morning here...

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