This Coffee Retailer Offers Potential 58%+ Returns

Talk about a caffeine high gone wrong! It’s been a wild ride for this specialty coffee retailer. Over the past 52 weeks, shares surged over 250%, from the mid-$40’s to nearly $116. Then shares reversed course, losing everything they gained and more. 

However, the stock looks to be heating up again…

Green Mountain Coffee Roasters (Nasdaq: GMCR) shares are struggling to emerge from a saucer bottom pattern. There is important resistance near $73. If they can penetrate this resistance there is little in their way of retesting their old high near $116.

Driving the potential push higher is heavily increasing demand for the coffee brewer’s patented single-serve coffee system, branded the Keurig machine and K-Cup coffee pod. 

Although the names are somewhat cumbersome, the coffee brewing process is extremely simple: pop in a pre-packaged K-cup coffee “pod.” Push a button on your Keurig machine. And, viola, a steaming cup of your favorite brew. 

This convenient way to make coffee is quickly catching on. According to the National Coffee Association, single-serve coffee is the second most popular method of coffee preparation, behind only conventional drip brewers. In 2011, approximately 7% of all coffee consumed in the U.S. was made from single-serve brew systems, up from 4% a year earlier. Single-serve coffee makers are also the quickest growing segment of the home coffee market, exceeding home cappuccino/espresso and drip machine sales. 

Although Green Mountain isn’t the only one-cup coffee company, it is the dominant U.S. player. Keurig machines account for over a quarter of all home and office brewers now in use in the U.S. And, according to Canaccord Genuity Research, Green Mountain could soon occupy over 40% of the home and office market.

What Green Mountain has over its competition — European rival, Nespresso, (SIX: NESN) and companies with similar technology, like Sara Lee (NYSE: SLE) — is exclusive arrangements to license its one-cup systems with many of America’s biggest coffee companies, including Starbucks (Nasdaq: SBUX), Dunkin Donuts (NYSE: DNKN) and Folgers (NYSE: SJM).

In addition to selling one-cup coffee systems at Starbucks, for example, Green Mountain also sells single-cup coffee pods in stores like Staples (Nasdaq: SPLA) and Bed, Bath & Beyond (Nasdaq: BBBY). And, the coffee retailer plans to keep adding both coffee brands and retail outlets to drive future sales.

Growth opportunities also exist in emerging markets, like Brazil and China. In fact, coffee analysts soon expect Brazil to become the world’s largest coffee consuming country.

All these factors bode well for Green Mountain.

Technically, the stock appears to be at an attractive entry point. Although shares are off more than 44% since the September 2011 peak of $115.98, they are steadily regaining ground.

The stock toppled after hedge fund manager, David Einhorn of Greenlight Capital, released a highly negative assessment of Green Mountain Coffee Roasters.

Following Einhorn’s comments, the stock tumbled to a low near $35, on very heavy trading volume. In the process, the Major uptrend — formed off the stock’s June 2010 of $21.83 low was broken. A steep downtrend line formed.

In November 2011, shares found support around $43. They hovered near that level for the remainder of the calendar year establishing the territory just above $40 as an important support level.

However, since early 2012, traders seem to have forgotten, or perhaps disregarded, Einhorn’s report. 

The stock is on a steep, accelerated uptrend. Following upbeat first-quarter results, released February 2nd, shares surged on high volume — blowing past a first level of important resistance near $53.75 which has also become new support. Shares also bullishly crossed back above the former Major uptrend line which currently intersects around $65. 

Green Mountain now appears to be emerging out of a saucer bottom basing pattern. If the stock, currently trading near $65, can retain upward momentum, it could challenge key resistance near $73.25.

If $73.25 is successfully broken, the stock could foreseeable complete the basing pattern and re-test its September 2011 $115.98 high. At current levels, this target represents a potential 58% gain. This bullish technical projection is supported by a strong fundamental outlook.

In early February, Green Mountain reported blow-out first-quarter 2012 results.

Due to soaring sales of Keurig coffee machines and K-cup coffee pods, especially over the holiday season, first-quarter revenue rocketed 102% to $1.2 billion, from $574.1 million in the year-earlier quarter. Analysts projected quarterly sales of only $1.1 billion.

For the upcoming second-quarter, the company expects revenue will increase 45 to 50% from the year-ago period, to about $1 billion.

Full-year 2012 estimates are equally strong. Due to continued demand for single brew coffee pods, Green Mountain projects annual sales will increase 60 to 65%, to approximately $4.3 billion, from $2.7 billion last year. By full-year 2013, analysts expect sales to ratchet up an additional 30% to $5.6 billion.

The earnings outlook is similarly robust.

Due to strong product demand, first-quarter 2012 earnings surged 233% to $0.60, from $0.18 per share in the comparable year-ago quarter. Wall Street expected earnings of just $0.36 per share.

For the upcoming second-quarter, Green Mountain expects earnings will be in the range of $0.60 to $0.65 per share, up at least 25%, from $0.48 per share in the comparable year-ago period.

As demand continues, the company projects full-year 2012, earnings will be between $2.55 to $2.65 per share, reflecting at least a 56% increase from $1.64 per share in full-year 2011. By full-year 2013, analysts expect earnings to increase an additional 43% to $3.64 per share.

Taking into account the expected earnings growth, the company’s PEG ratio (P/E divided by growth rate) is very attractive at 0.49 (17.8/36.3). Anything under one is normally considered an attractive valuation.

Given that Green Mountain projects double-digit earnings and revenue growth, backed by a technically bullish stock chart, I plan to go long on the specialty coffee retailer. I will place a buy-on-stop order at $73.27, just above current resistance. This means if the stock does not hit or go above this level, I will not enter a position.

My target is $115.96, just cents below a re-test of its recent September peak. My stop-loss is $53.73, just below current support. If the stock fell through this level, it would also break the Minor uptrend line. Based on the current trading price, the risk to reward ratio is approximately 4.5:1. 

Risks to consider: Some of Green Mountain’s K-Cup patents expire in September 2012. This change will enable competitors to make and sell some Keurig-like coffee products without paying royalties. As a result, traders may want to re-evaluate their position well before the September patent expiry. However, over the near-term, the growing market for convenient, high-quality home-brewed coffee should continue to drive Green Mountain shares higher.