Analysts Debate: Is Green Mountain Coffee Roasters Still a Hot Stock?

The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "motley," and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.

In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll be reviewing a pick from earlier this year, Green Mountain Coffee Roasters (GMCR.DL), the single-serve-coffee king.

Green Mountain Coffee Roasters by the numbers
Here's a quick snapshot of the company's most important numbers:

Sources: Yahoo! Finance and company filings. TTM = trailing 12 months.

Travis' take
This week I chose Green Mountain Coffee Roasters as our debate topic because we're sitting on a 116.6-point gain on this stock in our TMFYoungGuns CAPS portfolio, and I think it's at least worth thinking about taking a "CAPS profit."

The stock's big jump came after the company reported third-quarter earnings that obliterated expectations and left short-sellers flabbergasted. Sales were up 33% to $946.7 million, net income grew 22% to $91.9 million, and non-GAAP earnings per share of $0.64 crushed the $0.48 analysts expected. To make matters worse for short-sellers, inventories were only up 14%, and this was one of the big reasons people were negative on the stock.  

It looks to me like too many people drank the Kool-Aid that David Einhorn was selling when he made the short case for Green Mountain over a year ago. There was supposed to be some devastating impact on sales from expiring patents and competition from Starbucks and others getting into the single-serve market. Yet sales continued to grow and now the company is cash flow positive and continuing to grow the bottom line.

But is it time to sell?

The stock now trades at 17 times trailing earnings and 13 times forward earnings. Management still expects sales growth of 15% to 20% next year, which is a healthy number considering the company's size. I'm a little concerned about a large amount of capital expenditures, which is expected to lead to just $100 million to $150 million in free cash flow for the year.

I don't think Green Mountain is the steal it was when we made this pick, but I'm willing to let it ride for the time being. Any sign of slower-than-expected sales growth or decreased margins and I'm ready to push the eject button. For now, I hope we'll continue to see stronger-than-expected numbers and the short-sellers will be forced to push the stock higher.

Sean's take
I heard that Green Mountain was set to come out with a new flavor for its single-serve K-Cup coffee just for The Motley Fool YoungGuns -- a highly caffeinated flavor known as "D-D-D-Double!"

OK, all joking aside, we've been spot-on with our assessment of Green Mountain Coffee Roasters up until now. We hit Green Mountain almost perfectly at its lows, and it's essentially doubled since then. The question then becomes: What of Green Mountain now? Based on its fourth-quarter earnings report, I'd say the answer is: More of the same!

I doubt we're going to see the glory days of $100-plus per share anytime soon, but the figures produced by Green Mountain, even if you remove the benefit of a 53rd week, which only occurs every couple of years, were unmistakably strong. Inventory levels are under control, cash flow is expected to grow anywhere from 30% to 95% based on the $100 million-$150 million free cash flow guidance provided by the company, and its partnerships with Starbucks and Dunkin' Brands remain firmly intact.

Despite worries that patent losses for its K-Cup designs would inspire store-branded copies from grocers like Kroger (KR -0.61%) that would hurt Green Mountain, we've seen far from that based on the actual results. If one negative could be derived from this report, it'd be that sales of its higher-margin Vue brewing system were weak. Still, K-Cup volume increased 49% during fiscal 2012 and Keurig brewing systems shipments jumped to 9.2 million, including its partners.

Will sales slow? This seems highly unlikely over the near term. Green Mountain is projecting sales growth of 15% to 20% next year and is bringing in the experienced product supply officer of Coca-Cola's (KO 0.07%) North American refreshments division, Brian Kelley, to be its new CEO. Coffee prices have dropped dramatically from its lows and, at the moment, the Keurig is priced cheaper in more retail locations than Starbucks' recently introduced Verismo brewing system. Like Travis, I'm all for setting-and-forgetting Green Mountain at the moment. Let it ride!

Alex's take
I'd like to start by looking back at the table I created for the original Green Mountain debate. At the time, Green Mountain's P/E was 8.4, and its five-year average P/E was 44.7. Right now, after a bit more time spent at a low valuation, Green Mountain's average P/E is 44.2, and its current P/E is 16.5, according to Wolfram Alpha. That's still a 63% discount to its average. Although I don't think Green Mountain will be hitting the 40s again, getting halfway there isn't out of the question.

Compare Green Mountain's three-year progress to Starbucks'. Starbucks has a P/E close to double that of Green Mountain's at 29.7. Despite this discrepancy, and despite the fact that analysts expect Starbucks to grow at a faster rate next year, the fact remains that Green Mountain's fundamentals have obliterated Starbucks' for the last three years. This trouncing includes a head-to-head free cash flow growth comparison, which is one Green Mountain metric that continues to worry analysts. Even if Green Mountain slows down to the rates Travis and Sean have already mentioned, it would still be a faster-growing company than many with higher valuations and lower expectations.

I've probably been the most nervous of the three of us about a Green Mountain downturn denting our gains, but there's been a lot of news that's calmed me in recent months.

Starbucks' competing Verismo machine has not had many favorable reviews -- when it does get a rare positive write-up, reader comments are overwhelmingly negative. This is, of course, purely anecdotal so far, and we may not know anything about the device's sales figures until Starbucks' next quarterly earnings, but you can't compete with a market leader by releasing a product that doesn't impress.

I'm also quite interested in seeing how new CEO Brian Kelley continues Green Mountain's growth in the upcoming year. Coca-Cola's business isn't really analogous to Green Mountain's, but experience in beverage retail should be readily transferable. Handling supply chain logistics for Coke's huge North American operations is bound to have given Kelley some insights that will streamline Green Mountain's troublesome inventory issues. One hopes that he's also got the chops to expand Green Mountain's sales footprint, but Coke was eager to let him head a 68,000-strong operating division. That wouldn't have happened if Coke didn't expect him to improve sales in its most mature region.

I'm warier of buying shares now than I would have been before -- and I kick myself for not opening a position when we made the call -- but I think there's enough upside ahead to keep this outperform call open. The leash will be shorter than it was last time, but I'm not going to yank it back unless something serious crops up.

The final call
It's unanimous: Green Mountain Coffee Roasters will keep its outperform call from us -- nothing to sneeze at, considering our usual disagreement. For the rest of our picks, which are currently beating the market by 182 points, check out our TMFYoungGuns CAPS page.