Analysis: Green Mountain Coffee shares seen rising

By Mihir Dalal

Reuters

November 7, 2011

(Reuters) - David Einhorn may not like Green Mountain Coffee Roasters Inc (GMCR.O), but many on Wall Street think the hedge fund manager overstated the risks and are still attracted to the growth potential of the top single-cup coffee company.

Green Mountain's shares slumped almost 40 percent to a seven-month low after Einhorn warned on October 17 that the company's business model was weaker than most thought and that its accounting was suspect.

The stock has since recovered almost half its losses and many analysts think it has much further to gain. There are more 'Strong Buy' recommendations among StarMine-rated analysts now than three months ago and the average 12-month price target for the stock is $117, far above its $70.31 close on Monday.

"There are so many aspects to Einhorn's thesis that are 180 degrees counter to what we know that it's hard to believe investors give much credence to the presentation," said Mitchell Pinheiro, an analyst at Janney Capital Markets.

Last year, Green Mountain conducted an accounting probe and restated its results after the U.S. Securities and Exchange Commission (SEC) said it was looking into revenue recognition practices and its relationship with its sole Keurig distributor, M.Block & Sons.

Einhorn said the inquiry is likely to have a "material" impact on the company and Green Mountain and M.Block were "potentially engaged in a variety of shenanigans that appear designed to mislead auditors and to inflate financial results."

However, Robert Willens, author of the Willens Report, which analyzes corporate accounting and tax matters for investors, said his study showed Green Mountain's "accounting is not objectionable or questionable. It seems quite sound."

Willens, who examined Green Mountain's accounts at the request of some clients, said the company might be recording some revenues prematurely, but believes this is not an uncommon issue, given the complexity of revenue recognition rules.

"I didn't see anything in their revenue recognition policies that made me uncomfortable. I didn't see any evidence that they were recording fictitious revenues," he said.

Three Green Mountain shareholders, who spoke on condition of anonymity, said all of Einhorn's criticisms had been raised and addressed at various times in the past.

The shareholders, who together own a little over 1 percent of Green Mountain stock, said the comments from the Greenlight Capital hedge fund founder have not changed their views on the stock. One even increased his holdings after the sell-off.

PATENT GROWTH

Waterbury, Vermont-based Green Mountain has been a stock market darling in recent years -- the shares soared to almost $116 six weeks ago from below $10 in March 2009 -- reflecting the explosive growth of its Keurig coffee machines, which have become hugely popular for their ability to quickly and cleanly brew one cup of coffee at a time.

That growth is seen continuing at least for the next few years.

"Keurig will be a major coffee brand in the United States," said Ric Rhinehart, executive director of the Specialty Coffee Association of America.

"It's going to replace the traditional roast and ground business from the major branded companies over the next few years. It could get into 25 million households, that's almost 30 percent of all American households."

The company's growth has been aided by patents covering the technology used in Keurig machines and its K-Cup refills. These patents expire in September 2012 and, if the company is unable to renew them, other firms will be able to make and sell coffee for Keurig brewers without paying the company royalty.

Einhorn said the patent expiry is a big threat to Green Mountain earnings as the company mostly sells the machines at cost and earns its profits from the high-margin K-Cup refills.

Janney's Pinheiro disagrees about how big the threat is, saying Green Mountain has acquired brand loyalty from consumers, as well as licensing deals with top coffee brands, including Starbucks Corp (SBUX.O) and Folgers (SJM.N).

"There will be incursion into Green Mountain's share if the patents expire. The question is: who is going to be able to compete with them, given their manufacturing and distribution scale?" Pinheiro said.

While Einhorn said Green Mountain could, at best, earn $3.50 a share a year, the average forecast among StarMine-ranked analysts is for earnings of close to $4 a share in the year to September 2013.

Suntrust Robinson analyst William Chappel sees potential for earnings to hit $9 a share over the long term.

Green Mountain is due to report its full-year results on Wednesday.

"We used to work with an analyst who regularly carried EPS estimates on his recommended stocks several standard deviations higher than anyone else," Roth Capital analyst Anton Brenner wrote in a recent note.

"He managed this by assuming a best-case for every single line item in the income statement. Einhorn does this in reverse."

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(Reporting by Mihir Dalal in New York; editing by Anthony Kurian, Ian Geoghegan and Andre Grenon)