Green Mountain Coffee Isn't Done Roasting Returns

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus, hence this regular series.

Next up: Green Mountain (Nasdaq: GMCR  ) . Is the would-be king of caffeinated home brew the real thing? Let's get to the numbers.

Foolish facts

Metric

Green Mountain Coffee Roasters

CAPS stars (5 max)

*

Total ratings

1,006

Percent bulls

67.6%

Percent bears

32.4%

Bullish pitches

120 out of 186

Highest rated peers

Seneca Foods, John B. Sanfillippo & Son, J&J Snack Foods

Data current as of Sept. 30.

Allow me to admit a bias up front. Not only is Green Mountain Coffee one of our best-performing picks in Rule Breakers, it's also the best-performing pick on my Motley Fool CAPS scorecard -- an 11-bagger over the past four years. The run-up has many Fools wondering if now's the time to sell, or short.

"Coffee along with the other soft commodities are on a stellar run which is expected to continue, but even with the company's acquisitions I can't justify their current valuation of $4.1 [billion]. Consistently positively cash flow from operations but they are looking to take on a lot more debt now to finance more acquisitions, and I feel they are way overbought right now and due for a pullback," wrote All-Star investor jamespeer two weeks ago.

He's been proven right since then. Shares of Green Mountain fell more than 5% yesterday on news that the Securities and Exchange Commission (SEC) has opened an inquiry that may involve the coffee roaster's revenue-recognition practices. An investigation could take months, leading to a slow and steady decline in the share price.

What we know so far is that Green Mountain admits an accounting error from 2007 wherein management overstated per-share earnings by $0.03. The company booked $0.11 in diluted earnings that fiscal year; a little more than 25% will now be erased.

That's significant. But does it alter the rest of Green Mountain's remarkable growth story? I'm not so sure.

The elements of growth

Metric

Last 12 Months

2009

2008

Normalized net income growth

121.1%

86.8%

79.3%

Revenue growth

68.8%

60.5%

46.4%

Gross margin

32.3%

31.1%

35.4%

Receivables growth

88.1%

67.1%

39.1%

Shares outstanding

131.7 million

130.8 million

109.4 million

Source: Capital IQ, a division of Standard & Poor's.

Picasso couldn't paint a better growth picture than the one Green Mountain has created. Let's review:

  • Revenue and net income growth have accelerated in each of the past three years. ('Nuff said.)
  • Green Mountain hasn't needed excess receivables growth in order to generate massive revenue and income gains. This suggests a measure of operating leverage in the underlying business.
  • But it's gross margins where this story gets really interesting. Green Mountain says its newly revealed revenue recognition problems are the result of miscalculating margins. The implication? Margins will be adjusted downwards, impacting net income. And yet the impact may not be huge. Gross margins have already declined in the wake of outrageous growth over the past three years, which, again, looks like operating leverage at work.

Competitor and peer checkup

Competitor

Normalized Net Income Growth (3 yrs.)

Green Mountain Coffee Roasters

95.9%

Kraft Foods (NYSE: KFT  )

3.1%

Peet's Coffee (Nasdaq: PEET  )

32.1%

Procter & Gamble (NYSE: PG  )

1.8%

Sara Lee (NYSE: SLE  )

4.8%

Starbucks Coffee (Nasdaq: SBUX  )

10.7%

Source: Capital IQ, a division of Standard & Poor's. Data current as of Sept. 30.

Green Mountain is the overwhelming winner in this table, no doubt due in part to its acquisition and successful marketing of the K-Cup single-cup brewing system, which Starbucks has since copied with its VIA instant brand. So be it. Success breeds imitators.

Grade: Sustainable
Will the imitators take a straw to Green Mountain's cup of profits? They haven't so far, and I don't believe they will now. Instead, I see the SEC inquiry surfacing troubling issues as the biggest threat to investors at current prices. But given management's record of excellent stewardship in years past, I suspect the agency's findings will include minor infractions and nothing more. I'm sticking with my outperform call.

Now it's your turn to weigh in. Do you like Green Mountain Coffee Roasters at these levels? Would you make it one of our 11 o'clock stocks? Let the debate begin in the comments box below, and when you're done, click here to get today's 11 o'clock portfolio pick.

You can also ask Tim to evaluate a favorite growth story by sending him an email, or replying to him on Twitter.

For further Foolishness featuring Green Mountain Coffee Roasters:

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Green Mountain Coffee Roasters is a Motley Fool Rule Breakers recommendation. Starbucks is a Motley Fool Stock Advisor selection. Procter & Gamble is a Motley Fool Income Investor pick. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. The Motley Fool owns shares of and has written covered calls in Procter & Gamble and is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.


Read/Post Comments (5) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 30, 2010, at 2:15 PM, refriedbean wrote:

    I bought more on the pull back and they don't call me the "Oracle of the Ozarks" for nothin'.

  • Report this Comment On September 30, 2010, at 2:27 PM, sandysanmina wrote:

    Of course revenues are soaring . they sell goods to Timothy's and then BUY Timothy's and consolidate the inflated Timothy sales into their books. Same with Dietrich.

    Hey they sell $1 worth of goods to a company who in turn sells it to consumers for $1.25. Upon the acquisition of that firm the goods are ultimately booked once at wholesale and once at retail. No rapid increase in inventory to send up a red flag but in time one has to ask why they would spend $158MM to buy $163MM of intangibles and goodwill at Timothy's. To record the $1 of goods as $2.25 worth of sales? This smacks of a ponzi scheme For the past 3 acquisitions they have swapped more than $460MM of cash for $470MM of VAPOR assets , intangibles and goodwill.

  • Report this Comment On September 30, 2010, at 5:20 PM, PROWBELL wrote:

    Two things need to be corrected. The first is in the article with the .03 overstatement. The .03 is cummulative over 3 years which would be 0.1 per year not .03 in 2007. Read the company's filing from 10/28/2010. The second is with the previous post. GMCR did not sell product to Timothys. Timothys was a licensed Kcup producer which GMCR collecter a royalty from the Kcups sold by Timothys - around .06 per cup. GMCR has been acquiring all available Kcup licenses from other coffee companies by acquisition. They make around .15 per Kcups that they sell. With the increase in Kcup sales this is a no brainer ! Do a little research before you post.

  • Report this Comment On September 30, 2010, at 9:24 PM, corrysj wrote:

    More importantly, these accounting irregularities could continue to manifest as the SEC delves deeper into their investigation. I was all set with limit orders around $28, but after Cramer put GMCR in the 'Sell' block (Thurs), I'm going to stay away indefinitely. I'm sure the 'Pros' are going to heavily short the stock if they aren't already.

  • Report this Comment On October 07, 2010, at 1:22 AM, thidmark wrote:

    "Read the company's filing from 10/28/2010."

    Well, now, there's the problem. They are filing reports into the future.

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