Friday, August 16, 2013

Green Mountain Coffee: Director Makes A Million Dollar Bet

I was quite pleased to learn that my latest article on Green Mountain Coffee (GMCR) was selected as an "Editor's Pick" by the editorial staff at Seeking Alpha.  As expected, Green Mountain Coffee: Illegal Insider Trades Signal More Risk Ahead brought out the faithful Green Mountain fan-club to denounce the "heretical and devil-tongued beast" that I am.  Needless to say, the article raises even more questions about the previous management team.    

However, there was a bit of bright insider news related to GMCR this week.  A.D. David Mackay, an independent director elected to the Green Mountain Coffee board late last year, ponied up more than $1M in an insider trade filed August 16, 2013. Mackay's purchase is notable as it is the first direct insider purchase in more than a year.

A.D. David Mackay, 57, served as the Chief Executive Officer of Kellogg Company from December 2006 to January 2011 and as its President from August 2003 to January 2011. Prior to that experience, he served as the Chief Operating Officer of Kellogg from 2003 to 2006. Although only a Class III director, Mackay's resume brings industry and "street" credibility to the GMCR board.

Perhaps Mr. Mackay is making an effort to show his confidence in the company's future, but $1M is a costly happy-face. The timing of his investment is very interesting. It's also refreshing to see some "blue" amidst a sea of "red".   

Sunday, August 11, 2013

Market Update for August 12, 2013

With second quarter earnings season earnings nearing the end, we thought it might be good to review some of the highlights.  According to Bloomberg, 87 percent of the companies in the S&P 500 have reported at this point.

Seventy-two percent of those companies beat the consensus estimate for earnings per share, and 56 percent beat the consensus estimate for revenue. Those results compare with 3 percent and 49 percent, respectively, in the first quarter. In the second quarter, the average beat relative to estimates has been 2.7 percent for EPS and 0.4 percent for sales. In the first quarter, the average beat on EPS was 5 percent, while the average revenue miss was -0.5 percent.

It appears that companies were able to beat what might be referred to as “conservative” EPS guidance provided by management.  Of the S&P 500 sectors, financials performed well with earnings growth north of 28% and 8.6% growth in revenues.

EPS Growth
Consumer Discretionary
Consumer Staples
Health Care
Info Tech

Source: Bloomberg

Considering that financials account for about 16% of the total S&P 500, it’s easy to see how well the overall index performed.  However, Michael Farr, President of Farr Miller & Washington suggests that EPS growth for the overall S&P 500 index would have been closer to 0% if not for the financials.

Much of the growth in EPS and revenues looks to be the result of reducing loan loss provisions and reserves.  This of course would account for much of upside in EPS compared to last year.  Mr. Farr thinks the good results in banks and insurers are due to accounting gimmickry.  We are inclined to agree.

That said, corporate profit margins are at all time highs, yet revenue growth appears constrained.  This would suggest earnings estimates for 2014 may prove to be too high.   

Being summer, it has been a slow volume tape.  However, we took advantage of earnings season to nibble on a handful of stocks prior to or following their earnings announcements:    

Recent Buys:

American Express (AXP): second-quarter profit rose 4.9%, beating Wall Street expectations, while spending by its credit-card customers increased 7%.  However, revenue (net of interest expense) came in below estimates.  Immediately following AXP’s earnings report, an EU proposal to cap fees charged by banks to process credit card payments was announced.  The subsequent -5.5% decline in share price had “shoot first and ask questions later” written all over it.  We used the pull back to initiate partial positions in AXP.
American Express one month

Dr. Pepper Snapple (DPS): second-quarter earnings fell 13% as packaged beverage sales continued to weaken, particularly in the U.S.  However, gross margins did improve slightly and sales in Latin America rose 12%.  Management’s progress in Mexico and Latin America is gaining traction.  We used the -4% pull-back in share price to take small positions in DPS.  

Domino’s Pizza Inc. (DPZ): second-quarter adjusted earnings beat consensus estimates, while Q2 revenues grew more than ten percent y-to-y.  The headline numbers did mask some compression in gross margins, but same-store-sales growth in their international markets is consistent and impressive. Despite an otherwise decent earnings report for DPZ, shares retreated more than -3.5% following the news.  We view the weakness as a tradable opportunity.  (Note: positions have since been closed).

General Dynamics (GD): Defense and aerospace operator posted better than expected Q2 earnings, due in large part to significant revenue growth in their aerospace segment.  We initiated small positions prior to their earnings report.  Shares are up almost 4% since our purchase.
General Dynamics one month

Embraer (ERJ): Shares of the Brazilian plane maker got chopped for a tax hit incurred in Q2 as a result of depreciation in the Brazilian real during the period.  Under IFRS accounting rules, the company is required to record taxes resulting from unrealized gains or losses due to the impact of the exchange rate between the Real and US dollar. 

Guidance from management did indicate economic concerns and softening demand for the Legacy 650 business jets, particularly in China.  However, ERJ’s back-log is quite robust and we view the tax hit as a “deer in the headlights” event.  We are surprised by how many analysts (who get paid big bucks to know these things) failed to factor in IFRS accounting rules into their estimates.  We used the pull-back to take small positions in ERJ.  

Intel Corp. (INTC): Q2 profit fell some 29% as the chip maker continued to be hurt by sinking demand for personal computers. The company lowered its full-year revenue outlook, now seeing its sales roughly flat from the previous year.  Although we realize the “tail wagging the dog” implications of falling PC demand and INTC’s latent entry into mobile computing, naysayers fail to realize the company’s superb operating efficiencies.

Analysts had been barking for months about the possibility of forecast cuts.  They got it from INTC management in the Q2 earnings report.  Buy-side analysts don’t always get it right (despite their need to have strong opinions).  However, the sell-side folks who are notorious for hedging their calls couldn’t get it right either.    

INTC management has a long record of value creation and an excellent history of generating strong cash-flow.  At end of the day, you have a company with a solid balance sheet and get paid well to wait.  Nibbled at the $23 area.   

Recent Sells:

Facebook (FB): Q2 EPS and revenues beat on both fronts.  Shares popped 20% on the news and keep chugging higher.  We think of FB as an advertising play (social media is the disguise) but the company figured out how to monetize the mobile ad.  We missed out on some of the post-earnings upside, but it was a fantastic trade.

Recommended Reading:  Being a bear on Tesla Motors (TSLA) hasn’t been too popular the past several months.  Just ask Seeking Alpha contributor John Petersen.  Mr. Petersen, partner in the law firm of Fefer Petersen & Co. (and a CPA) knows a thing or two about due diligence and accounting.    

His recent article titled Tesla’s Non-GAAP Fairy Tale presented an excellent but critical analysis of Tesla’s financial reporting and accounting practices.  It garnered an enormous amount of response, most of which were from angry bulls.   Shares of Tesla (TSLA) have been on fire lately, up more than 80% since May. It makes performance of the S&P 500 look like a snail by comparison (below).  
Tesla vs. S&P 500 (3 month comparison %)

I know all too well what it’s like to be in the wrong neighborhood.  Green Mountain Coffee (GMCR) is a perfect example.  It’s rare that I dive into the “commenter” fray with volatile stocks, but this was too good to pass up.  I jumped into the conversation on several occasions swinging a bat in support of Petersen’s astute observations.  His argument offered a very sober, but compellingly grim view of Tesla’s funky accounting representations.  

Needless to say, the Tesla BULL crowd is a tough room to work!  How dare some interloper (a lawyer/CPA mind you) crash the Tesla party!  Rubbish they cried!  John took a pummeling from most (some repeatedly) but, he handled the discussions with grace and professionalism. It's contributors like John who bring class to the Seeking Alpha community. For anybody who follows Tesla stock or is curious about the company, his article is a very worthwhile read.