Until this autumn, Green Mountain Coffee Roasters (GMCR) was a darling of Wall Street and of investors, who rejoiced as its stock price soared to more than $100 by September 2011 from a mere $4 a share in 2007. Then hedge fund manager David Einhorn took aim at everything from the company’s growth prospects to its accounting methodologies, disparagingly referring to its growth trajectory as little more than froth. That was bad enough, but then last month, despite reporting continued growth, GMCR failed to meet analysts’ estimates when it reported earnings for its fiscal year, which ended September 30. That knocked more stuffing out of the stock, which as of this week was changing hands for about $57 a share after trading as low as $40.
Investors buffeted by the stock’s tremendous volatility and desperately seeking some clarity on the company’s prospects might be interested in trying to gauge not only the sum total of GMCR’s earnings in dollars, but the quality of those earnings. As has been shown repeatedly over time, those companies whose earnings come from sustainable sources are likely to generate better financial results over the longer term. Sadly, GMCR doesn’t appear to fall into this camp: its StarMine Earnings Quality (EQ) score is a mere 5 on a scale of 1 to 100, with 1 representing the lowest quality earnings. That puts the coffee company firmly in the bottom decile of companies in North America, delivering a decidedly bearish signal.
Even a quick glance at the chart below reveals some of the reasons for the company posting such a low score. GMCR’s net operating asset turnover has been falling for the last two years and now languishes well below the industry median (represented by the gold line on the chart). Asset turnover measures how efficiently a company uses its assets to generate revenue, and our model measures both the absolute level and the rate of change in asset turnover. The fact that asset turnover is declining is a warning signal for anyone trying to understand how sustainable a company’s earnings will prove to be in the coming months and years. Nor is that the only bearish news. In the quarter that ended September 30, 2011, GMCR reported capital expenditures of $108 million, its highest level on record. Combined with the fact that the company reported its largest-ever negative cash flows from operations (a negative $171 million), this delivers another warning signal to investors: this heavy capital spending level isn’t sustainable if it isn’t backed by solid cash flows.
Source: Thomson ONE / StarMine
Based on the data in the chart below, which shows a big jump in the number of days of inventory in both absolute and relative terms and confirms that GMCR is experiencing an inventory build-up, it’s easy to see why Einhorn criticized GMCR’s inventory management. (For more details read this Reuters News article which refers to Einhorn’s reasons for turning negative on the stock.) This metric is a key component of the cash cycle for the company, since it measures the speed at which a company transforms each dollar invested in working capital into a dollar of cash received.
Source: Thomson ONE / StarMine\
GMCR and its management team face an interesting 2012 as they try to address investor concerns with respect to both accounting issues and earnings quality. We’re not saying Green Mountain is doing anything wrong, but when David Einhorn raises a red flag – as he did when he correctly predicted the demise of Lehman Brothers in 2008 – the market pays close attention. Einhorn presented his analysis of Green Mountain Coffee at the Value Investing Congress event this past October. At the prior year’s event, he presented a short thesis on St. Joe (JOE). That stock now trades roughly 40% below the levels it did immediately prior to that investment conference. While GMCR is still a high-growth company and could emerge from its current rough patch as an even stronger company, the signs simply don’t seem to point to that happening very quickly.
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