Green Mountain’s Upside Comes With High Risks

Shares of Green Mountain Coffee Roasters (NASDAQ:GMCR) have more than doubled this year on strong quarterly results. The reason why Green Mountain’s profits beat estimates were primarily due to lower coffee prices, which widened the gross margins by 720 basis points. It is important to note that while the bottom-line swelled, the top-line was on the lower end of the company’s guidance.

See our full analysis of GMCR here

Green Mountain exclusively sells Arabica coffee. Arabica prices have plummeted in the last twelve months and are trading at a three year low. ^[1] Most of the declines are are due to tepid coffee demand from Europe combined with a record output from the world’s biggest coffee producer, Brazil.

But what goes down must come up – sooner or later. Green Mountain has little control over the global coffee prices, so if coffee prices were to rise, it would hurt the company’s margins significantly. Furthermore, there are signs that there could be some revival in coffee prices.

Coffee Prices To Rebound?

In August, Dilma Rousseff-led Brazilian government decided to initiate two programs to boost reference prices for coffee farmers in the country. In the first program, the government will offer 343 reais ($149) for a 60 kg bag for an option contract to be delivered in late 2014. In the second, farmers will be offered 307 reais per bag for immediate deliveries. Currently, the farmers receive about 285 reais for a 60 kg bag. Coffee prices spiked 2.5% after the announcement. ^[2]

Some of the recent economic data coming out of Europe has been encouraging as well. The manufacturing sentiment across the Euro zone recently hit a 26-month high; the air cargo traffic has improved and the German and British economies are doing well overall. The automotive market in Europe has also shown some green shoots lately. These are signs that the worst may be behind in Europe. ^[3]

Europe is the biggest consumer of coffee in the world so any pickup in its economic activity is likely to push coffee prices up. High unemployment rates combined with austerity measures implemented by the various governments had squeezed people’s disposable income. As a result, more Europeans traded down to the cheaper robusta grade of coffee. However, if the economic situation improves, people may revert back to arabica as coffee drinking is an integral part of the European lifestyle.

A company like Green Mountain is even more sensitive to coffee prices than Starbucks or Dunkin’ Donuts. Coffee constitutes a lower proportion of the total costs for a restaurant chain since it usually sells them at a higher price. On the other hand, the price of a K-Cup is lower when compared a coffee cup at a cafe. Thus, there exists a significant downside risk to Green Mountain’s profits.

We have a $71 price estimate for Green Mountain Coffee Roasters, which is about 15% lower than the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. indexmundi.com [↩]
2. Brazil Launches Measures to Boost Coffee Prices, August 7, 2013, wsj.com [↩]
3. Europe’s Economy Recovering: Three Positive Signs, Including Strong Manufacturing (PMI) Data, Air Freight Traffic, Encouraging UK Story, September 3, 2013, ibtimes.com [↩]