Einhorn's Bearish Call on Green Mountain Coffee Was Right. So What's Next?

David Sterman's picture

Thursday, November 10, 2011 - 9:00am

by David Sterman

Score one for David Einhorn. The high-profile short-seller recently gave a series of speeches outlining concerns about one of the top-gaining stocks in 2011: Green Mountain Coffee Roasters (Nasdaq: GMCR). I recently looked at whether the stock might head to $120, as one sell-side analyst predicted, or would fall from its mid-$60s perch as Einhorn predicted.

I concluded that "On the face of it, Einhorn scores some strong points, most notably that the company has failed to generate real cash out of this business and may fail to do so once the key patents expire in 11 months. Even assuming that Einhorn is too bearish, this stock still looks expensive, trading at 40 times Merrill Lynch's projected fiscal 2013 free cash flow forecasts."

Well, Green Mountain "spit the bit," delivering a slightly weak fiscal fourth quarter in the after trading hours of Wednesday, Nov. 9. As a result, its shares lost one-third of their value. Ironically, the quarterly shortfall has little to do with Einhorn's specific contentions about alleged accounting fraud and looming competition. Instead, Green Mountain saw a sudden and surprising slowdown of orders in the wholesale distribution channels in which it deals. Sales of the single-serve K-cup coffee pods fell by $10 million sequentially to $475 million. Regardless of the reason, short sellers, which owned 21 million shares short as of the most recent available data, are likely to cover their positions and cause the stock to rise now that they've secured a tidy profit.

Despite the severe plunge in the stock, which erased more than $3 billion in market value, fourth-quarter results weren't all that bad. Earnings per share (EPS) of $0.47 trailed consensus forecasts by just a penny. Similarly, management's full-year profit guidance of about $2.60 in EPS in fiscal 2012 is right in line with current analyst forecasts. Yet it's the trajectory of the company's growth that is now called into question. Green Mountain had been topping sales and profit forecasts by an ever larger margin during the prior four quarters, leading analysts to continually boost their long-term outlooks.

That beat-and-raise catalyst for the stock is now likely over. Analysts had been expecting Green Mountain's sales to rise 60% in the fiscal year that began in October. As of now, they're largely sticking by that forecast.

What are analysts saying?

KeyCorp: "We believe the 4Q earnings miss was primarily related to retailer buy-in ahead of the [up to]30% price increase on K-cups in 4Q and retailer inventory adjustment that were not consistent with recent trends. We are encouraged by the fact that [second-half 2011] K-Cup volumes were up 76% compared to [up to] 65% in the first half." KeyCorp analysts cut their price target from $120 to $80.

Merrill Lynch: Noted that management satisfactorily addresses Einhorn's concerns on the call and add that "end demand signals indicate that momentum has not broken." A price target of $90 was reiterated.

Action to Take --> With shorts covering, sell-side analysts still talking up the name and valuation no longer at obscene levels, look for a moderate bounce-back in Green Mountain shares. The stock could easily move back to the $60 mark as bulls dominate bears in near-term trading. Over the long haul, Einhorn may be on the mark when he suggests that rising competition when key patents expire next September could spell trouble for the company. So this looks like a solid trade, but a still-risky long-term investment.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.