Peet s Coffee & Tea Inc.

Transcription

1 UNIVERSITY OF OREGON INVESTMENT GROUP January 15th, 2010 Consumer Goods Peet s Coffee & Tea Inc. RECOMMENDATION: HOLD Stock Data Price (52 weeks) Symbol/Exchange PEET / NASDAQ Beta Shares Outstanding 13.3M Average daily volume 303,555 (3 month average) Current market cap = 455M Current Price Dividend Dividend Yield Valuation (per share) DCF Analysis $27.11 Comparables Analysis Target Price Current Price BUSINESS OVERVIEW $39.09 $ Summary Financials LTM (Thousands) Revenue: $298,700 Net Income: $13,000 Operating Cash Flow $29,900 Peet s Coffee & Tea (PEET) is a specialty coffee roaster and marketer of fresh roasted whole bean coffee and tea. Their coffee is sold under strict freshness standards through multiple channels of distribution including grocery stores, home delivery, office restaurant and foodservice accounts and Company-owned and operated stores in six states. Company operations are broken down into two reportable segments: retail and specialty sales. Covering Analyst: Lee Lenker LLenker@uoregon.edu The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational. Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be. Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG s portfolio. In addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG s portfolio.

2 Retail Segment (66% of Total Revenue) As of December 28 th, 2008 the PEETs operates 188 retail stores in six states through which they sell whole bean coffee, beverages, pastries, tea and other related items. Each store is designed to facilitate the sale of fresh whole bean coffee and to encourage customer trial of the various coffees. Each store has a bean counter with an employee assisting customers with questions on coffee origins and on home brewing. PEET upholds its high freshness standards by never serving coffee that is older than 30 minutes. Specialty Sales (34% of Total Revenue) The specialty sales segment can be broken down into three subcategories including grocery, home delivery, along with foodservice and office. 1. Grocery: In addition to PEET s retail stores, the company sells its products through a network of grocery stores including Safeway, Albertson s, Ralph s, Kroger, Publix, and Whole Foods Market. One of the HR programs facilitating these operations is what PEET calls their Direct Store Delivery (DSD) system. Currently, the company has 51 DSD sales representatives, along with 160 independent distributors to support the company s expansion into new grocery accounts. Their duties involve making deliveries 1-3 times a week, properly shelving the product, rotating to ensure freshness, erecting free-standing displays, and forging store-level relationships. Management believes that the grocery segment will provide the highest source of revenue growth in 2010 as new accounts are acquired. 2. Home Delivery: The company implements a pull-style of distribution by roasting to order, and shipping coffee directly from the roasting facility to Home delivery customers. Sales for this segment are generated through the company s website (Peets.com). The site offers a proprietary tool that allows customers to manage the timing and delivery of recurring orders called the Peetnik Loyalty Program, which rewards the most loyal customers to the company. 3. Foodservice and Office: This segment of the company is managed by a staff of sales and account managers who makes sales calls to potential accounts and conduct audits on existing accounts. The company has two models for servicing these accounts that are referred to as We Proudly Brew ( WPB ) along with licensing accounts. WPB accounts are where PEET provides the equipment and product to brew and resell. The licensing accounts involve the creation of a full Peet s beverage store within another location like an airport, grocery store or college campus. 2

3 BUSINESS AND GROWTH STRATEGIES The specialty coffee category is highly competitive, and is dominated by Starbucks Corporation whom is larger than all other competitors combined. There are currently over 20,000 gourmet coffeehouses in the United States. Along with Starbucks, PEET competes with a number of small single unit mom and pop coffee houses and local chains within their geographic niche including Coffee Bean & Tea Leaf, Tully s, and Caribou Coffee. Outside of the coffeehouse business, the company also competes with Green Mountain Coffee, Illy Caffe, Millstone, Seattle s Best, and Dunkin Donuts as well as numerous smaller, regional brands. The company s market share in the specialty category in each of the three channels discussed previously, is driven by the quality of the product. This differentiated quality is founded on their bean selectivity, freshness standards, and artisan-roasting style. As Peet s continues to grow, company operations will continue to be vertically integrated. This enables PEET to control the quality of their product at all stages. High-quality Arabica coffee beans are purchased from all over the world, and through the use of their artisan-roasting technique they bring out the distinctive flavor in their coffees. An important fact is that roasted coffee is perishable, therefore PEET does not stock or inventory roasted coffee. They roast-to-order, and ship fresh coffee daily to stores and customers. Their control of purchasing, roasting, packaging, and distribution of coffee allows them to maintain their commitment to freshness, is cost effective, and enhances margins and profit potential. Management believes there are growth opportunities in all of the company s distribution channels. Specialty sales can expand to geographies where they do not have a retail presence. The first priority of the company has been to develop primarily in the western U.S. market where the company has established brand identity, and have high customer awareness. In the long-term the company plans to open new retail stores in strategic west coast locations that are consistent with the company s demographic profile along with partnering with distributors and companies who share the same passion for quality and freshness. Here is the current Breakdown of the company s respective retail locations: 3

4 Coffee as a Commodity Coffee commodity costs began to decline in July 2008, after over four years of increases. Peet s uses derivatives/futures contracts to hedge against the risk of the volatile coffee market and historically has locked in contracts up to a year in advance. Below is a chart of the respective international coffee prices in the last eleven years. The prices of coffee are volatile to do the inability to accurately predict unforeseen weather conditions, which can adversely affect the amount of exports from coffee-producing countries. INDUSTRY The Current U.S Economy The current economic recession has put a stranglehold on disposable income in the United States. Recognizing this threat is important, as PEET targets a customer seeking an experience with their coffee, contrary to the consumers who purchase their coffee from a fast-food establishment, or coffee drive-thru. Management has stated that revenues and performance depend significantly on consumer confidence and spending. Taking a glance at Per-capita disposable income is important for recognizing this threat. Disposable income can be defined as money available after tax and non-tax payments have been paid. It is a major concern and risk for an industry that is subject to the whim of the consumer s dollar. The following graph taken from Ibisworld illustrates the projected % change in disposable income through Per-Capita Disposable Income: 4

5 In 2010 this forecasts that per capita disposable income will grow by 0.6% year-on-year. Wages are forecast to increase as production increases. Unfortunately, with this increase, comes an inverse correlation with Unemployment, as it looks to continue to rise in Below is a graph of the projected forecast through Unemployment Level- National The increased disposable income level seen previously may or may not offset the increased unemployment. In years the national unemployment level looks to recover which will be vital for Peet s autonomy. However, due to the company s strong presence in California, which holds one of the nation s highest unemployment rates, the effects of increased employment may take longer to materialize. Coffee Production Industry Producers within this industry mainly purchase Arabica, Robust and Peaberry varieties of coffee beans and subsequently process them into roasted or ground coffee products. Manufacturers predominantly sell their finished coffee products to grocery wholesalers, retailers, the foodservice industry and overseas export markets. Here is a breakdown of the respective market segments. Primarily driving the revival of the coffee production industry was the changing landscape of consumer dietary patterns and the increased emphasis on healthy living and lifestyles. Scientific studies have enabled coffee manufacturers to aggressively promote the various health benefits of coffee MAJOR MARKET SEGMENTS Market Segment Share Grocery wholesalers 73.2% Exports 12.4% Retail trade 10.0% Foodservice industry 2.5% Direct sales 1.9% 5

6 consumption. Further, the rapid expansion of coffeehouses and its associated social aspects also renewed demand and drove industry growth over the current performance period. The sustained increase in per capita coffee consumption, combined with the rapid growth of the specialty and gourmet coffee segment will largely drive industry revenue over the outlook period (Peet s Segment). Further, the projected declines in crude oil and coffee bean prices over the next few years should translate into lower industry costs and higher profit margins. The ability of the industry to adapt to changes such as the rise of the ethical consumer and the increased awareness of fair-trade and organic coffee production methods will largely impact future demand and consumption. MANAGEMENT AND EMPLOYEE RELATIONS The current CEO of Peet s is Patrick O Dea, who has been with the company since May of 2002, after having served a stint with Proctor and Gamble, as well as Mother s cookies, where he marketed several brands. The current CFO is Thomas Cawley, who has been with the company since July of 2003 after having worked for Pepsi, Pizza Hut, and Gap. The company employees Jim Reynolds whose official title is the Roastmaster Emeritus he has been buying coffee for more than 30 years, and is one of the most respected professional in the gourmet coffee industry. Doug Welsh is the current Coffee Vice-President who joined the company in 1994 as a taste-trainer. He now oversees inventory management, coffee purchasing, and quality control. The experienced management of Peet s Coffee and Tea is a strong qualitative factor for the company, as they have been able to withstand the strong economic downturn in a fragile industry. PORTFOLIO STATUS Svigals: Currently Underweight Small-cap and Consumer Goods Tall Firs: Currently overweight small-cap 2%, underweight Consumer Goods Dadco: Not benchmarked. RECENT NEWS December 7 th Peet's Coffee & Tea Will Not Enhance Latest Proposal and Will Leave in Place Existing Offer to Acquire Diedrich for $26.00 Per Share December 15 th Peet's Coffee & Tea Announces HSR Clearance in Connection with Proposal to Acquire Diedrich January 8 th 2010 GMCR extends offer to buy Diedrich. 6

7 S.W.O.T. ANALYSIS Strengths Peet s Coffee & Tea is vertically integrated, enabling the control of the product at all stages. Loyal customer base. Peet leverages their Peetnik Loyalty Program. Peets has no long-term debt and is able to facilitate their expansion efforts through cash and marketable securities. Weaknesses Geographic niche market in California, and consequently exposed to the highest levels of unemployment in the country. Specialty coffee category is highly competitive with Starbucks holding a greater retail market presence than all other competitors combined. Company only has one roasting facility, if operations become inefficient, the entire supply chain is affected. Opportunities Analyst forecasts show strong growth in the gourmet coffee industry through Huge growth opportunities in all segments of the business. I.E. Ample of amount of grocery accounts, as well as untapped geographic markets within the U.S. May Acquire Diedrich (DDRX), this would be a very large addition to the Specialty Revenue Segment, as DDRX s entire business is in the wholesale industry. Threats Business is highly dependent on a single product, specialty coffee. If demand for specialty coffee decreases, the business will suffer. Volatile coffee bean prices may adversely affect and increase the cost of goods sold for Peet s Coffee. Roasting methods are not proprietary, so competitors may be able to duplicate them, which could harm Peet s competitive position/market share. 7

8 COMPARABLES ANALYSIS The following comparables analysis was conducted using three metrics. Below is an explanation of the reasoning behind each metric, along with a description for each of the comparable companies. Each company s description was taken from their respective 10k. I selected the following metrics: EV/Revenue - This was used to measure size of the company in relation to its ability to generate revenue. EV/EBITDA This is a good measure of the profitability of a company against its peers since it eliminates the impact of financing and accounting differences. EV/Operating Cash Flows This is a measure of how much cash a firm generates compared to the total value of the firm. Note: For the EV/OCF calculation, Farmer Brothers was treated as an outlier, due to its negative OCF. Consequently, SBUX and CBOU were both weighted 40%, with GMCR holding the balance of 20%. Also, cash of $17M was added back to enterprise value. Starbucks Corporation (SBUX) -- 35% Starbucks is the premier roaster and retailer of specialty coffee in the world. Starbucks Corporation was formed in 1985 and its common stock trades on the NASDAQ Global Select Market ( NASDAQ ) under the symbol SBUX. Starbucks (together with its subsidiaries, Starbucks or the Company ) purchases and roasts high-quality whole bean coffees and sells them, along with fresh, rich-brewed coffees, Italian-style espresso beverages, cold blended beverages, a variety of complementary food items, a selection of premium teas, and beverage-related accessories and equipment, primarily through Company-operated retail stores. Starbucks also sells coffee and tea products and licenses its trademark through other channels such as licensed retail stores and, through certain of its licensees and equity investees, Starbucks produces and sells a variety of ready-to-drink beverages. All channels outside the Company-operated retail stores are collectively known as specialty operations. Caribou Coffee (CBOU) 35% Founded in 1992, CBOU has developed into the second largest company-operated gourmet coffeehouse operator in the United States based on the number of coffeehouses operated. As of December 28, 2008, we had 511 coffeehouses, including 97 franchised locations. CBOU coffeehouses are located in 16 states, the District of Columbia and international markets. Their coffeehouses focus on creating a unique experience for customers through the combination of high-quality products, distinctive coffeehouse environment and customer service. Their products include high-quality gourmet coffee and espresso-based beverages, specialty teas, baked goods, whole bean coffee, branded merchandise 8

9 and related products. To maintain product quality, they source the highest grades of Arabica beans, craft roast beans in small batches to achieve optimal flavor profiles and enforce strict packaging and brewing standards. They consider our roasting methods essential to the flavor and richness of our coffee. Additionally, they sell their high-quality whole bean and ground coffee to grocery stores, mass merchandisers, office coffee providers, airlines, hotels, sports and entertainment venues, college campuses and on-line customers. Green Mountain Coffee (GMCR) 15% Green Mountain Coffee Roasters, Inc. is a leader in the specialty coffee and coffee maker businesses. They sell over 200 whole bean and ground coffee selections, cocoa, teas and coffees in K-Cup portion packs, Keurig single-cup brewers and other accessories. In recent years, a significant driver of the Company s growth has been the sale of K-Cups and Keurig brewing systems. They manage their operations through two business segments, Specialty Coffee business unit (SCBU) formerly referred to as Green Mountain Coffee (GMC), and Keurig business unit (Keurig). SCBU sells whole bean and ground coffee selections, as well as K-Cups in domestic wholesale and retail channels and directly to consumers. In addition, SCBU sells Keurig single-cup brewing systems and other accessories directly to consumers and more recently to supermarkets. Keurig is a pioneer and leading manufacturer of gourmet single-cup brewing systems and targets its premium patented single-cup brewing systems for consumers at home (AH) and away-from-home (AFH) mainly in North America. Keurig sells its AFH single-cup brewers to distributors for offices and its AH single-cup brewers to select retailers such as department stores and club stores for at-home use. Keurig sells coffee, tea and cocoa in K-Cups produced by a variety of roasters, including SCBU, and related accessories to select retailers such as department stores and club stores and also directly to consumers. Keurig earns royalty income from the sale of K-Cups shipped by its licensed roasters. Farmer Brothers Co (FARM) 15% Farmer Bros. Co., a Delaware corporation (including its consolidated subsidiaries unless the context otherwise requires, the "Company," "we," "our" or "Farmer Bros.") is a manufacturer, wholesaler and distributor of coffee and non-coffee ("allied") products to the institutional food service segment. We were incorporated in California in 1923, and reincorporated in Delaware in We operate in one business segment and are in the business of roasting, packaging, and distributing coffee and allied products through direct and brokered sales to our customers throughout the contiguous United States. 9

10 Their product line is specifically focused on the needs of our market segment: institutional food service establishments including restaurants, hotels, casinos, hospitals and food service providers, as well as retailers such as convenience stores, coffee houses, general merchandisers, private-label retailers and grocery stores. Our product line includes roasted coffee, liquid coffee, coffee related products such as coffee filters, sugar and creamers, assorted teas, cappuccino, cocoa, spices, gelatins and puddings, soup, gravy and sauce mixes, pancake and biscuit mixes, and jellies and preserves. DISCOUNTED CASH FLOW ANALYSIS Revenues: The percent of sales method was used for this analysis. Revenue for PEET consists of Retail and Specialty customers. Projected revenues for Peet s retail segment, were based on the amount of new retail stores opened, the number of mature stores (in existence greater than 3 years), and the number of immature stores (in existence less than 3 years). The following is a breakdown of the forecasted store openings through 2019: As observed from the chart, 2009 shows little growth in store openings. Management wanted to take a conservative approach in 2009 after a poor fiscal year in 2008, and decided to focus on other revenue generating segments within the company; their primary emphasis on their wholesale segment in Grocery Stores. As the economy begins to recover, management has stated they expect to return to normal levels of growth, as they continue to tap into reachable markets throughout the U.S. with their primary emphasis in the West Coast. After having projected store openings, an appropriate model could be formulated to project total retail revenues. Below is a chart showing these projections: The number of Mature stores (>3 yrs) figure is derived by taking the total # of retail stores figure from three years previous as can be seen from the model above. On average, the company has stated that a mature store can generate $1.2M each year. This figure was taken from the k, and was grown by 2% 10

11 each year to account for inflation. Multiplying the # of mature stores, by their expected annual revenue per store, arrives at the total mature retail store revenue. Next, required finding the number of immature stores (< 3 yrs), which took the current year retail stores and subtracted the amount of mature stores. Average annual immature store revenue was $698,688. This figure was also grown by 2% each year to account for inflation. Multiplying the number of immature stores, by their projected annual revenue arrived at the total immature retail store revenue. Thus, adding mature and immature arrives at a total retail revenue figure for each year. Following the retail revenue segment, is the specialty revenue segment. The key underlying assumptions within this model include the following: 1) Management expects wholesale grocery sale revenues to reach $150m by ) Grocery sales will be the main growth driver for specialty sales, with the expectations of achieving thousands of additional accounts in the coming years. While management as stated they feel there is growth potential in all facets of their business, there was very little emphasis put on home delivery and food service/office. I projected little change in both of these categories due to guidance, while also holding the Retail Rev/Specialty Rev Ratio (66/34) relatively constant, with a shift towards a greater share in Specialty revenue generation. Below shows the previous yrs allocation: 11

12 Capital Expenditures: To begin making projections for total Capex, I first had to figure out the total cost per new retail store. Managerial guidance stated that approximately 8-10 stores would be opened in 2010, with a total cost of $8.5m. This enabled me to arrive at a ball-park figure for cost per store. The following model outlines the projections made for Capital Expenditures: Note for Capex: Cost per retail location was grown 3% annually. I felt that this would adequately account for increased prices. Also, you will note the additional expenditures column, this is money allocated towards store renovations and other miscellaneous additions. Starting in the year 2013, I have another column beginning, this is due to company guidance and the probability that if the company is to expand at its projected rate, they may need to obtain an additional roaster or renovate their current facilities which is costly. Beta: In order to calculate the beta I ran a 5-yr monthly regression against the S&P (SPY) to arrive at a beta of.765 which is comparable to both Yahoo and Google finance projections. As seen in the comparables analysis, many of their comparable companies hold significantly higher betas which is partially attributable to their higher levels of long-term debt that PEET does not have. After running a Hamada, I felt that the 5-yr regression was an accurate representation of what the company s beta should be. Cost of sales and related occupancy expenses: This includes product costs, manufacturing costs, rent and other occupancy costs. As a percent of net revenue, cost of sales decreased from 47.5% in 2007 to 46.9% in The decrease was due to the leverage of costs related to the roasting facility opened last year and increased prices in retail and grocery partially offset by higher green coffee costs. Management expects cost of sales and related occupancy expenses to continue to decrease in the next few years, due to leveraging the new roasting facility, improved waste management in retail, and neutral commodity costs in aggregate. I have it lowering by.25% through 2013, leveling out, and then increasing by.2%. 12

13 Operating Expenses: Operating expenses consist of both retail store and specialty operating costs, such as employee labor and benefits, repairs and maintenance, supplies, training, travel and banking and card processing fees. Operating expenses as a percent of net revenue for 2008 increased 0.3% to 34.7%. The increase was primarily due to higher costs associated with expanding the grocery business (0.7%), opening 53 new retail stores in the last two years (0.2%), partially offset by favorable workers compensation insurance expense (-0.3%) and other cost savings. Beginning in 2010, I have this projected at 35.15% of revenues, and growing by.05% each year thereafter. Depreciation: Historically, depreciation has been 4% of revenues. I have projected depreciation out starting with 4.5% of revenues in 2009, and growing by.05% annually. SG&A: This line has been 8.5% historically. Management expects this to lower in the coming years due to new technology implementations. RECOMMENDATION Weighting the comparables and discounted cash flows analysis each 50%, I arrive at an implied price of $ With the current price at $33.69, my analysis implies an overvaluation of 2%. Peet s Coffee & Tea Company has a very unique business model, and may encounter significant growth due to industry expectations, and I feel that these high-growth expectations have been adequately priced into my revenue models. With that taken into consideration, I am recommending a Hold for all portfolios, with hopes of finding a better company to purchase. 13

14 APPENDIX 1 COMPARABLES ANALYSIS 14

15 APPENDIX 2 DISCOUNTED CASH FLOWS ANALYSIS 15

16 APPENDIX 3 DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS APPENDIX 4 BETA SENSITIVITY ANALYSIS 16

17 APPENDIX 5 SOURCES Ibisworld Census.Gov Peets.com SEC.gov (PEET 10k s, 10q s) Google Finance Yahoo Finance International Coffee Organization ( Bloomberg 17