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Greenberg: Red Flags Still Fly Over Green Mountain

If there were ever proof that earnings quality doesn’t matter it would be today’s 18% rise in Green Mountain Coffee Roasters to an all-time high.

AP

As responders to my Twitter tweets keep trying to remind me: It’s all about the momentum.

“Keep fighting the momentum of stocks and you will continue to be wrong,” writes one.

Feeling a lot like I’ve seen this movie before — 1999, anybody? — I responded: “In the end fundamentals generally win out. There’s a stock, there’s a company and with momentum and/or value they often diverge.”

In the case of Green Mountain : The coffee company, best known for its Keurig brewers and related K-Cup coffee pods reported better than expected results last night. But the quality of those earnings, the company’s strategy and continued accounting issues continue to raise red flags.

Not that anybody cares (I'm being half cynical) – but here are a few reasons investors might want to look beyond the movement of the stock:

  • As of the most recent quarter, there appears to be a meaningful deceleration in sales of coffee K-Cup cartridges — not generally good for a company that relies on the razor-razor blade concept. That’s the word from Stifel Nicolaus analyst Mark Astrachan, who is nervy enough to rate the stock a sell and in the past has raised accounting issues that have fallen on deaf ears. (Note: His K-Cup sales analysis was based on his estimates, because the company has stopped providing K-Cup shipments, was equally unimpressed with the latest results.)
  • Sliding gross and operating margins sequentially and year-over-year.
  • Looming 2012 patent expiration on K-Cups, Green Mountain’s principal product. (It generally sells its brewers at cost or even a loss to get the K-Cup sale. It’s a classic razor/razor blade model.) With patent expiration, Astrachan believes system-wide profitability risks falling as competition rises.
  • As previously reported, a division of TreeHouse Foods has rolled out its own version of a private-label coffee pod (to Wal-Mart, among others) that works in a Keurig brewer. It’s being sued by Green Mountain for patent infringement.
  • Vague plans to roll out a new brewer with re-engineered K-Cups whose patents expire in 2021. Will existing customers really switch for the sake of switching? And if they do, now that they’re better educated with single-serve, will they shop the market? Will Starbucks, with its own brewer, be part of that market? (Starbucks has hinted it will, with little detail.) Either way, Astrachan says, “The new platform encourages increased competition where all entrants essentially start from scratch.”
  • To create the new platform capital and expand existing capacity, the company said cap spending this year could near $300 million; that’s well more than double last year – a risk for a company with $1 billion in debt and $32.9 million in unrestricted cash.
  • Green Mountain steers the investors to view the company on a non-GAAP basis, excluding acquisition-related expenses, amortization of identifiable intangibles and SEC inquiry expenses. According to its earnings release, in 2009 general and administrative expenses accounted for 4.6% of revenues; in 2010, 3.8% even though revenues rose by 67%. Had they kept stable, earnings per share would have been 16 cent – in line with estimates, rather than beating by 2 cents. (Actually, beating by 1 cent if you take out gains on foreign exchange and financial instruments.)
  • According to AnalytixInsight, which tracks earning quality, as of the end of the company’s last fiscal year Green Mountain’s return on capital has trailed peers in the food industry, suggesting it “might be operationally challenged.”

An SEC investigation into accounting issues continues.

And that’s just the most obvious. Beyond that, everything else is just perky.

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