I don't know what's gotten into the coffee sector, but investors seem to like it. Whether it's the caffeinated beverages or the rising price of coffee beans worldwide, investors are sipping up coffee stocks like they're going out of style -- and it's producing some sky-high valuations.
Green Mountain Coffee Roasters
Even with yesterday's 24% drop, Coffee Holding, a manufacturer, roaster, packager, marketer, and distributor of blended coffees in the U.S. and Canada, still appears grossly overvalued. Now down 22% from its all-time high set earlier in the week, the company is still up more than 500% since the year began. I suggest we take a closer look at Coffee Holding so you can make up your mind whether this stock is just getting started or if, as I feel, shareholders are about to be burned to a crisp.
|Profit Margin (TTM)||3.1%|
|Levered Free Cash Flow (TTM)||$0.98 million|
Source: Yahoo! Finance.
On paper, the company's five-year growth projection of 11.6% and forward P/E of 29 seem reasonable. Heck, I can even swallow a PEG ratio of 1.76 without spitting up my coffee. Where the hint of overvaluation starts to become an unwavering stench is when we begin examining its recent growth, its margins, and its cash flow.
Coffee Holding relies very heavily on Green Mountain for its business. In fact, Green Mountain last quarter accounted for 47% of Coffee Holding's revenue in 2010. While some may cheer the strength behind Green Mountain's trust in such a small company, it's worrisome that so much of Coffee Holding's revenue is tied up with one company.
Even more concerning are the company's razor-thin margins and surprisingly weak free cash flow. Full-year revenue has risen by 63% since 2006, but free cash flow remains stagnant. In the trailing-12-month period, the company failed to produce even $1 million in levered free cash flow. Doing the math, this means Coffee Holding is trading at a whopping 125 times its levered free cash. Compare this to Starbucks and Peet's Coffee, which trade at a still pricey but relatively reasonable 44 and 63 times levered free cash flow, respectively, and you'll see why I think shareholders are playing with fire.
History has often shown that it's a dangerous idea to invest in a company that relies on one customer for a large percentage of its revenue. While coffee prices remain strong and Green Mountain is showing no signs of slowing down, Coffee Holding's lack of growth in free cash flow, coupled with its small profit margin, make it a coffee stock that could seriously let down its shareholders.
What's your take on this recent highflier? Are you feeling jazzed about its prospects or just jittery after looking over its balance sheet? Share your thoughts in the comments section below and consider adding Coffee Holding to your watchlist to keep up on the latest in the coffee sector.Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Starbucks and Green Mountain, as well as creating a short position in Peet's Coffee & Tea and Green Mountain. Motley Fool newsletter services have recommended creating a lurking gator position in Green Mountain. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that four out of five dentists recommend.