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Buy, Sell or Hold: Are the Shorts Right About Green Mountain Coffee Roasters?

Early investors in Green Mountain Coffee Roasters (NASDAQ: GMCR) rode a coffee-high all the way to $111 per share. But in a 10-month period during 2011 to 2012 investors were hit with a caffeine let-down.

Shares of GMCR fell all the way to $17, losing 85% along the way.

More recently, however, Green Mountain Coffee Roaster's price has been "percolating" again.

Since the lows back in July 2012, the share price has risen over 150% and is up over 80% from the November 2012 lows alone.

That begs the question of whether or not the story has changed. Is GMCR the right play for the "gritty" investor or is now the time to make a "smooth" exit?

Here's the breakdown…

The Questions Behind Green Mountain Coffee Roasters

What GMCR does is quite simple. It primarily does two things: Manufactures and sells the Keurig brewer as well as manufacture and sell the packs, termed K-Cups, which are used with the Keurig to brew a premium single cup of coffee.

The single-serve packs accounted for nearly 65% of revenue ($863 million) and the brewers accounted for approximately 28% of revenue ($377 million) in the recently released first-quarter 2013 earnings report.

With such a simple business model you'd think it would be easy to evaluate the company, right? Well, it's not.

So many questions swirl in GMCR's cup – from its plans to grow; its increasing competition; its possible accounting mishaps; and its very large short interest – that getting a handle on this company is tricky.

Here's why.

The K-Cups, which account for the majority of GMCR's business, have been patent protected. However a number of these patents have expired, which leaves the door open for competitors to join the fray and produce knockoff K-Cups that work with the Keurig brewer.

This last quarter was the first opportunity to see how well the K-Cups fared with this new competition. To the surprise of some, they did quite well. Sales of single serve-related products increased 19% over the prior year period.

But it may be a little early to say that GMCR has a handle on this situation, since more competitors are gearing up to enter this niche market by the end of 2013. Wal-Mart's Café Escapes and SUPERVALU's private-label brand are already on the shelves and more are on their way.

What's more, GMCR lowered the price of some popular K-Cups last year by 8 cents. Will more price cuts be on the horizon as the competition increases? How loyal will the K-Cup addicts be as even more generics hit the shelves?

Some argue that the competition will benefit GMCR as other coffee pod formats will disappear and the K-Cup becomes universal. This will naturally lead to more sales of the Keurig brewer.

But even if you assume this is so, there is also competition in the single-cup brewer market. The main competitor is Starbucks with its Verismo brewer.

Thus far the Verismo has not fared well in gaining any market share traction. Consumers were taken aback by the price of the machine as well as the price of its pods. In response, Starbucks lowered the price of the Verismo over the holiday season.

Even though the Verismo brewer has been a disappointment for Starbucks thus far, I wouldn't be so quick to dismiss a company like Starbucks given its deep pockets and international appeal.

Even still, GMCR has been the dominant player in a now mature North American brewer market. Further growth will need to come from overseas. To that end, GMCR has made some alliances with Italian coffee giant Lavazza and others to expand abroad, but it has been very limited in scope thus far.

Meanwhile, Starbucks is well equipped to harness its vast popularity abroad and pre-empt any attempt for GMCR to expand internationally. Therefore, even though Starbucks's first go at a brewer may have failed, they are clearly not finished exploring new ways of getting a toehold in the space.

Other competitors include Mondelez's (Kraft) Tassimo and Nestle's Nespresso – which is quite popular in Europe.

Even small appliance manufactures want their piece of the pie in the brewer market. With such powerhouses in place and ready to compete, GMCR will face a steep climb uphill as it tries to expand internationally.

But let's not forget this is a coffee company.

The price of coffee as a commodity has fallen nearly 40% since last year. This large drop will come as an advantage to GMCR as it works off the old higher priced beans in inventory and purchases new beans. This will already improve upon the hefty profit margins associated with the K-Cup.

However, the price of coffee as a commodity may be poised for a turnaround as it is already reaching 3-year price lows.

An interesting twist to coffee prices is that Reuters recently reported that many coffee makers have been quietly changing their coffee blends. Some are now substituting lower grade Robusta beans for pricier Arabica beans. GMCR is a premium brand and uses Arabica beans exclusively in their K-Cups.

As the competition starts adding Robusta to their pods and nobody cares or notices, what will the price of a cup of coffee be then? And will this be another reason why GMCR will be forced to lower the price of its K-Cup in the future?

The Short Story Behind GMCR

Then there's the short interest.

Famed short seller David Einhorn was almost single-handedly responsible for bringing down GMCR's share price from its all-time highs in 2011. He listed a number of issues that were of concern, but the Number One concern was GMCR's questionable accounting.

Subsequently, the SEC did investigate GMCR and some financial statements have been revised. Since then the share price has recovered to today's mid-40 range.

But as of last October, Einhorn still holds his short position and is still extremely negative about GMCR's accounting.

Suffice it to say, the short interest is large and stands at over 21% of the total shares of float while the short ratio is near 6.3.

On the other hand, GMCR stands on the opposite side since it is in the midst of a $500 million share repurchase program.

In this case there can only be one winner. Either the shorts will be rewarded if Einhorn is right about his analysis or GMCR could be in for a substantial short squeeze run as its business plan comes to fruition.

Good to the Last Drop

So if you enjoy riding the highs and lows from a caffeine fix – GMCR is for you.

In this case there are more questions than answers.

You have anxiety about the price of the K-Cup in comparison to the new generics coming down the pike. You have the adrenaline rush of growing overseas against some formidable opponents. You have the sleepless nights not knowing when or if more accounting issues will come up.

For me these issues do not make for a good investment.

Those holding the shares are simply "hoping" for good news out of the company that will trigger a short squeeze– or at the very least are "hoping" to be bought out by a larger player.

What's more, in these troubled economic times, does everyone have the counter space in their kitchen to equip it with such an extravagance in the first place?

As Keith Fitz-Gerald, Chief Investment Strategist for Money Morning, has repeatedly said, "concentrate on what the world needs as opposed to what it wants."

That's why I am a SELLER of Green Mountain Coffee Roasters.

About the Author: David Mamos brings nearly 15 years of analytical experience to the table with a background ranging from big-picture fundamental analysis to highly technical trading decisions. He began his career working as a financial advisor with Royal Alliance in 2001 and helped clients with portfolio management as well as buy-sell decisions before transitioning to the development, implementation and execution of trading strategies for aggressive investors.

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  1. Benton H Marder | February 20, 2013

    We all know the old advertising slogan, "You can't have just one". This is the way it is with coffee and tea. The whole concept of the Keurig is that we will pay per cup, rather than per pot. I use a small coffeemaker at home; I drink about three cups in the morning. I like decent coffee, and I'm willing to pay for it. I buy it as beans, and grind it and fire up the maker in less than a minute. To me, the economics of the K-cup are not so hot. Now, if I did drink but one cup at a time, I would load an empty pod with what I like, and go that way and save money. To many of us, the Keurig system is wildly expensive per cup when compared with using one's own coffee, no matter what it is. In this day and age, extravagance in little things adds up to major amounts. Most of us can't do this for very long.

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