Friday, October 21, 2011

Actionable Call Alert: Green Mountain Coffee (NASDAQ:GMCR)

SunTrust analyst William Chappell is literally pounding the table on Green Mountain Coffee (NASDAQ:GMCR) saying short seller David Einhorn is utterly wrong with his short thesis on the stock.

- Firm strongly reiterates Buy and adds to Top Pick status with $120 price target.

Chappell notes that Einhorn used their research reports (without their permission) as the basis for his negative conference presentation against GMCR. The report was made publicly available on Wednesday and the firm has since had a chance to “dissect his dissection” of their positive investment thesis.

- While there were no surprises in the presentation, the analyst does want to address several errors and omissions in that report to clarify his case. First, they remain comfortable in their $9 EPS analysis vs. his $3.50 estimate. The major errors to his math come on the “profit to split” analysis in which he appears to double-count the packaging costs, and his assumption for 20% private label share in k-cups, a penetration level which we will explain below to be STATISTICALLY impossible. Suntrust also notes that neither their $9 estimate, nor his $3.50 estimate, include potential profits from the highly profitable away from home segment.

Here are couple of examples of Chappell's counter:

Questioning the Starbucks Economics (slides 32 to 37)—As GMCR has previously said, it will make the same penny profit per k-cup on its brands as it will on partnered brands such as SBUX and Dunkin’ Brands. According to the investor, SBUX has said that it will make 2/3 of the profit and GMCR will make 1/3 of the total profit on each cup which, for the sake of argument, we will assume is correct. The problem lies in the investor’s math. Based on slide 35 he indicated that the total potential profit to share (i.e. split 2/3 to 1/3) is $0.22/k-cup. However, his analysis includes the assumption that BOTH companies will be paying $0.15/k‐cup for packaging when, in fact, SBUX is paying GMCR for the packaging services. If we eliminate this double‐count and assume that the cost of packaging is closer to $0.04-$0.05 per k-cup (based on prior statements by GMCR), the total profit to split is closer to $0.33/cup. If we then say that GMCR only takes a 1/3 of that profit per cup it would equate to $0.11, which is in line with our prior math.

Before leaving this item, we point out that, in our opinion, SBUX needed the GMCR partnership. Over the past decade, consumers were able to purchase single serve SBUX coffee through Kraft’s Tassimo system. But consumers overwhelmingly chose GMCR’s Keurig system (70% + market share of single serve system) vs. Tassimo (6% share), despite not having the option of SBUX. Additionally, SBUX only holds a 7-8% market share of coffee sold at retail and has been looking for new ways (i.e. Via) to expand that share. Again, we believe SBUX will still make more than $0.20 per k-cup so we doubt it looks at this as a bad bargain.

Private Label 20% Share Statistically Impossible (slides 63 and 66)—The second major driver of his $3.50 estimate is the assumption that non‐licensed private label cups will account for 20% of the total k‐cups sold. This comes from a quote from a “beverage Industry expert”. First, there are NO beverage categories outside of water and milk in which private label consists of 20% of the market. Second, private label only accounts for 10% of coffee sold at grocery, a level that has not deviated more than 1% per year for the past 10 years. That means it would take at least a 10‐standard deviation move to get to 20%; statistically impossible in the next five years.

- Second, Suntrust believes the implication that the company may have committed some sort of accounting fraud is a form of double jeopardy. While they do not outright reject the statement of a disgruntled M-Block employee from a six month old shareholder lawsuit, this statement relates to sales made in December 2009 and neglects to mention that GMCR already restated its financial results for FY08, FY09 and FY10 after a thorough review of the accounting.

In short, Chappell remain as confident as ever in the GMCR story and has moved it to their Top Pick among the 21 stocks he covers.

Notablecalls: This seems big as SunTrust's Chappell is countering Einhorn's claims with solid info and numbers. Not your typical 'We believe blah..blah..blah' type of defend we tend to get from the sell side.

Moreover, Einhorn used their models to present his short case. It appears he may have been wrong.

The stock is down 47 pts from its Sept highs, half of that over the past 4 days as funds managers blew out the name not to look stupid.

Greenberg was on CNBC yesterday, which probably attracted the retail shorts. They will get squeezed today. Big time, I suspect.

Given the nature of GMCR I would not be surprised to see it up 6-7 pts on this, putting 74-75 levels in play.

The shorts will have hell of a time keeping this one down.

I'm call this one Actionable Call (trading) Alert!

No comments: