Friday, November 06, 2009

Peet's Coffee (NASDAQ:PEET): Janney initiates with a Buy, sees $62-$87/sh fair value

Janney Capital Markets is out with an interesting call initiating Peet's Coffee (NASDAQ:PEET) with a Buy rating...and get this...$62-$87 fair value valuation range (official target stands at $62/sh).

With the pending acquisition of Diedrich Coffee (DDRX-$25.99; NR), PEET now has access to the fast-growing single cup segment of the specialty coffee category and is participating in this trend with the market leader, Keurig. Prior to the acquisition, PEET had been increasing EPS at a 25%+ rate despite a slowdown in the core PEET retail stores, driven by a rapid increase (20%+) in Peet’s branded coffee sales in the grocery channel. The one hole in PEET’s portfolio was the lack of participation in the rapidly growing single cup coffee trend, and this is now solved through the Diedrich acquisition. Prior to the acquisition, Janney forecast PEET has a three-year sales and EPS CAGR of 9% and 20%, respectively. With Diedrich, they forecast a three-year sales and EPS CAGR of 19% and 47%, respectively. At $37/sh, PEET is trading at 35.0x their 2009 EPS estimate of $1.06. While 2010 EPS will see the dilutive impact from the acquisition primarily in the form of non-cash goodwill amortization (~$0.50/sh), they expect EPS to more than double from the estimated 2009 level of $1.06 to $2.49 (ex-goodwill amortization) in 2011. Janney's current DCF-derived fair value of PEET excluding Diedrich is $40/share. Applying a forward P/E range of 25.0x to 35.0x (31.7x historical average) to their 2011 cash EPS estimate (including Diedrich) of $2.49 yields a twelve-month fair value target range of $62/sh to$87/share.

PEET’s leadership in specialty coffee is now enhanced with the ability to participate in the rapidly growing single cup coffee segment. Prior to the acquisition of Diedrich, PEET did not have a single cup offering. With the acquisition, PEET will now participate in the segment with the market-leading Keurig system (owned by Green Mountain Coffee Roasters (GMCR-$68.04; BUY).

PEET’s solid top line growth has been driven by grocery expansion (20%+ YTD). Growth in the channel has been the result of expanded geographic distribution into the Eastern U.S. At the end of 2Q09, PEET had added approximately 1,200 new grocery store accounts over the past twelve months for a total of 8,400 doors in the grocery channel. The addition of Godiva coffee to the PEET’s distribution system will provide incremental growth over the next 12 months.

PEET’s grocery distribution strength is an accelerator for Diedrich K-Cups penetration: PEET’s unique direct store distribution (DSD) system for specialty coffee has helped PEET gain meaningful share in a relatively short period of time in the grocery channel. Janney believes PEET’s grocery strength will accelerate Diedrich K-Cup sales through the grocery channel (currently very small).

Significant incremental earnings growth from Diedrich: Though management’s 2010 guidance range of $0.80/sh to $0.90/sh (compared to previous 2010 EPS guidance range of $1.24 to $1.30) implies roughly $0.35/sh to $0.50/sh of dilution related to the Diedrich acquisition in year one, Janney expects the acquisition to be on a cash basis ($1.45/sh cash vs. $0.92/sh GAAP). Management’s revised 2010 net revenuev guidance ($440 to $460 million) implies ~50% growth in Diedrich sales.

Single cup coffee a trend – not passing fad: Janney believes single cup coffee has clearly elevated itself from fad to trend. Led by industry leader Keurig (85% share of single cup brewer sales), they believe single cup brewing remains in the early innings of household penetration. Keurig brewers have been growing at a rate in excess of 100% over the last two years, and they believe this rapid growth will continue for the foreseeable future. Firm expects that the installed based of Keurig brewers will end 2009 in approximately 3.7 million homes and 375,000 offices. Based on approximately 90 million households with coffee brewers, Keurig’s share remains in the 4% range; they ultimately believe single cup brewing could reach 20% of all U.S. brewers - and Keurig is the far and away leader.

Impact of Peet’s branded K-cup: Janney estimates Diedrich has a current 14% share of systemwide K-cups through its Diedrich, Gloria Jeans, and Coffee People brands. According to Diedrich management, the Coffee People Donut Shop coffee is the number one selling K-Cup in the Keurig system, and their Gloria Jean’s Hazelnut coffee is the number one flavored coffee in the system. Given PEET’s loyal customer base on the west coast (and growing nationally), they believe PEET should help accelerate Keurig brewer growth and provide incremental K-Cup growth with the Peet’s brand.

Another way to look at Diedrich: Based on their estimate of systemwide K-Cup volume of 6.5 billion in 2012 and a 10% market share for Diedrich K-Cups (ex-Peet’s K-Cups), Janney estimate Diedrich would have volume of 650 million K-Cups. Assuming Diedrich’s gross profit is $0.10/K-Cup, Diedrich K-Cup gross profit would be $65 million in 2012. Assuming $10 million in selling expenses (could be less due to PEET infrastructure leverage); pre-tax earnings would be $55 million and on an after-tax basis on higher share count, would represent an incremental $2.15/sh to earnings in 2012.

Notablecalls: Wow - $62-87/sh fair value range for PEET sounds pretty amazing. Now, take look at the charts of GMCR, DDRX & CBOU - The coffee group.

The Coffee group are movers.

And now Janney comes out and blesses PEET, another coffee name with a huge, just HUGE price target.

I discussed the call with a fellow trader and this is what he had to say:

'... I would not be surprised to see PEET pushed to $39 today. I'm not even going to rule out higher levels. This stock has potential to go nuts...'

NC: I agree. I'm tempted to call this one Actionable Long.