Keurig Green Mountain (GMCR) surprised everyone, including me, with its fourth-quarter earnings this week. I was so pessimistic that I had purchased puts late last week, but cashed them in before the earnings hit, so I escaped with a profit. The stock is up over $6 in Thursday’s morning trading.
So what happened?
From what I can tell, nothing good. The numbers look lousy to me: For the quarter, net sales were down 13% to $1.04 billion, operating income fell 21% to $197 million and net income fell 15% to $131.3 million. For the year, sales were down 4% to $4.52 billion, operating income was down 14% to $861 million and net income fell 11% to $565.8 million.
I don’t see how declines of this magnitude can be good news. The ground-level data on sales segments was even worse. For the quarter, pod sales fell 9% and brewers/accessories plunged 32%. Sure, retail unit pod sales grew 7% in the quarter, saw a 4% decrease in equivalent services and 6% due to product mix.
There’s also nothing to be proud of in examining 2016 guidance and the company’s financial position. Keurig is looking to cut $100 million next year in expenses, which it also believes will cost it $10 to $14 million in cash expenditures to implement. It begs the question as to why operations are so inefficient in the first place as to need to cut costs.
GMCR Stock Is a Mess
GMCR blew through a billion dollars in cash repurchasing 9.5 million shares of GMCR stock, or about 6% of outstanding shares. Were I a shareholder, I’d be livid that the company bought back GMCR stock at $108 with the current price at less than half that.
Is that some kind of sick joke?
Valuing GMCR stock at $108 puts its at 30 times expected earnings … With management expecting reduced income next year, how could they throw a billion dollars at buybacks? To me, that’s criminal.
To add insult to injury, the company increased its dividend by 13% to $1.30 per share. So kiss another $200 million annually goodbye.
Looking further at 2016 guidance, the company expects free cash flow of $420 to $500 million, presumably after expected capex of $225 to 275 million. Now I’m not going to complain about free cash flow, especially when it’s that high. You could argue in favor of the dividend. But with cash on hand down to $59 million from $761 million last year, and $330 million in debt (up from $141 million), I consider the buyback to be a shameful use of capital.
So can anyone explain why investors are so exuberant about GMCR stock? Because I sure don’t get it.
Going forward, it’s the installed consumer base that is going to save the company’s butt, thanks to the free cash flow it’s going to provide. Yet with the 2.0 system earning lame reviews, the blowback that it will only accept GMCR pods and murmurs suggesting the Kold system is going to flop, I remain mystified as to how a company with $500 million in net income is sporting a $7 billion valuation. Yeah, that’s only 14 times earnings, so one might argue that the price is reasonable, given the free cash flow.
But since the stock market is a discounting mechanism, I don’t see how things are going to improve at GMCR to the point where it can support even the current valuation.
As for the market, however, anything is possible. Aggressive investors may want to jump in for a buy and try and execute a trade on the long side.
True investors in the company should sell on this bounce.
As of this writing, Lawrence Meyers did not hold a position in GMCR.
