This paper is a summation of extensive research into the current and forecasted valuation of Green Mountain Coffee Roasters (Nasdaq: GMCR). By utilizing the forecasted Free Cash Flow to Equity method, we derived an estimate of GMCR’s actual stock value. These results give us a true market value of $108.50, meaning that as of right now the company is undervalued by 29.9%–the stock closed at $76.09 per share as of 6/07/13 (Yahoo! Finance). The information contained herein details GMCR’s business model, the coffee production industry as a whole, GMCR’s strengths, weakness, opportunities, and threats, detailed financial projections, the results of and reasoning for our valuation, and why we believe that the company is currently undervalued.
Green Mountain Coffee Roasters (Nasdaq: GMCR), along with its subsidiaries (most notably Keurig) is a premier specialty coffee and coffeemaker company located in Vermont, U.S. The company sells Keurig? Single Cup Brewers and roasts high-quality Arabica bean coffees including single-origin, Fair Trade, certified organic, flavored, limited edition and proprietary blends offered in K-Cup? (ground coffee in a small plastic container which combines with water to make single-cups of coffee) and Vue packs that can be prepared in their Keurig? Single Cup Brewers. The company also sells traditional whole bean and ground coffee in other packaging such as bags, fractional packages, and cans. Additionally, the company produces and sells other specialty beverages besides traditional coffee in its single-serve packs. These products include hot apple cider, hot and iced teas, iced coffees, iced fruit brews, hot cocoa and other dairy-based beverages. Under the Keurig? brand name (which the company acquired in 2006 for $160 million), the company offers a variety of brewers for commercial use in the Away From Home (“AFH”) channel and for home use in the At Home (“AH”) channel. The breadth of features and sizes offered differentiates the channels. BUSINESS UNITS
Green Mountain Coffee Roasters inc. from now on referred to as GMCR, operates from three different business units. First is the specialty coffee business unit. The specialty coffee business unit includes Green Mountain Coffee, Tully’s coffee, Diedrich coffee, and Coffee People. Than we have the Keurig business unit which holds the rights to the Keurig Single Cup Brewing System. And lastly is GMCR Canada, which deals with GMCR in Canada and it also includes the Van Houtte business and Timothy’s World Coffee brand. Figure 1 shows the amount of revenue each business unit produced: Figure : Amount of Sales by Business Unit
Revenues have dramatically increased over the past 3 years from about $1,356.8 million in 2010 to $3,859.2million in 2013. Specialty Coffee Business Unit (SCBU)
The SCBU is focuses on producing, sourcing and selling coffee, hot cocoa,
teas, and other beverages through a variety of super markets, convenience stores, restaurants, and also directly to consumers. It also produces coffees, teas, and other beverages to be single serve cups in the form of K-cups of Vue packs to go along with the sales of the Keurig Single Cup Brewing system. The SCBU increased sales for fiscal year 2012 by $586.7million, 61% of total sales, $1,550.4million. Keurig Business Unit (KBU)
The KBU focuses primarily on selling and marketing its patented single cup brewing systems for at home and away from home use and its accessories in the United States. KBU sells single cup servings of coffees, teas, cocoa, and other beverages for the Keurig Brewing System. The KBU focuses on households as well as offices and office distributers, and consumer grocery stores. It recognizes royalty income when any third party ships any of these products. The KBU recorded at increase by $494.6 million to a total of $1,683.3 million. A percentage raise of 42%. Canadian Business Unit (CBU)
The CBU focuses on the production and selling of coffees, teas, and other beverages in a wide variety of packaging forms to Canada. It primarily sells to supermarkets, club stores such as Costco, offices, and restaurants. It only recently started selling and manufacturing Keurig K-Cups Single Cup Brewing System, and its accessories within Canada. Its net sales grew by $98.6 million, or 57%, to a total of $625.5 million for fiscal year 2012. BUSINESS MODEL
GMCR’s primary business model in terms of their growth strategy involves developing and managing marketing programs aimed at driving adoption of Keurig? Single Cup Brewer in North American homes and offices. The strategy behind this lies in generating continuing demand for the single serve packs. To achieve this aim, the company sells their AH brewers at, near, or when factoring in selling expenses, sometimes below cost. The company also has licensing agreements with Jarden Inc. (producer of Mr. Coffee? brand coffeemakers), Conair, Inc. (producer of Cuisinart? brand coffeemakers), and Breville Group Limited under which these companies produce, market, and sell coffeemakers co-branded with Keurig. GMCR has experienced rapid growth in
the last few years, for instance posting a 116% increase in gross profit between the year’s 2010 and 2011. This amazing growth has been driven primarily by the growth and adoption of the Keurig? Single Cup brewing systems and related K-Cup? sales. In fiscal 2012, approximately 90% of their consolidated net sales ($3,859 million) came from the combination of single serve packs and Keurig? Single Cup Brewers and related accessories. Supply Chain
GMCR has roughly just over 7,000 suppliers whom they contract with to be able to provide their high-quality products. As with any retail company, a reliable and resilient supply chain is extremely important to their business model. GMCR has always had a large focus on social and environmental sustainability. According to the company’s sustainability report on their website: “GMCR commits to long-term relationships that sustain healthier communities and create the highest-quality products – whether we are helping our suppliers keep pace with our Company’s continued rapid growth or assisting partner organizations to develop new programs for coffee farmers to better support their families”.
All supply chains for major corporations are inherently complex and unique to the industry in which they operate. The nature of GMCR’s supply chain is dual: they are a beverage company that “sources raw ingredients, as well as a maker of small appliances’. Most of their small appliances are made in Asia. The considerations necessary for a factory community in these often crowded urban areas is extremely different from a small farming village in Central America. Social Responsibility
GMCR prides itself in connecting to the communities in which their suppliers operate. Without a focus on the places they’re sourcing their inputs, there is more volatility in their ability to produce their products. To these ends, the company maintains close contact and open discussion with the farmers producing their beans. The company also regularly conducts unannounced factory floor tours to ensure appropriate working conditions for employees. Anyone familiar with the still-lingering branding perceptions from sweatshop conditions and Nike to the FoxConn and Apple connection knows
that these conceptions can affect shareholder value. These practices and others allow the company to engage in and build partnerships with the people directly responsible for helping GMCR grow their business. This is extremely important to the businesses branding image, which adds to the firm’s value. By listening to the regional concerns in these areas, the company is able to fund bold expansion projects. The company has grant programs with project collaborators to: “Focus on challenges and appropriate solutions related to food security, access to water, education, and health care. From coffee farmers around the world, to apple growers in Washington state and brewer manufacturers in Asia, our ability to weave together our many grant making and relationship development efforts across the diverse locations and workplaces that make up our supply chain allows us to create a uniquely satisfying beverage experience and brew a better world at the same time.” INDUSTRY ENVIRONMENT
The Green Mountain Coffee Roasters (GMCR) competes primarily in the coffee and coffeemaker markets. Their coffee, tea and other beverages competes directly against specialty coffees and teas sold through the channels of supermarkets, club stores, mass merchants, specialty retailers, and indirectly against all other coffees on the market. Competitors include numerous local and regional companies, and larger national and international companies. Some of these companies may have much greater resources. GMCR also competes for the retailer shelf space for our products, and some of those retailers are market competitive products under their own private labels such as the Safeway Select. GMCR also competes with conventional products of larger companies. Products are in competition with one another based on quality, price, brand recognition and loyalty, innovation, promotions, nutritional value, and further by the ability to identify and satisfy consumer preferences. The coffeemaker industry is also a highly competitive market where they compete against larger companies that possess greater marketing and operating resources than GMCR. The primary methods of competition are basically the same as the specialty coffee: price, quality, product performance and brand variations. GMCR competes against all sellers of the coffeemakers including companies that produce traditional pot-brewed coffeemakers and other single serve manufacturers. Some of these companies
include, but not limited to: Starbucks Corporation (including its Verismo brewing system), Nestle S.A. (including its Dolce-Gusto brewing system), Robert Bosch GmbH (including its TASSIMO brewing system), and Bunn-O-Matic Corporation. GMCR’S COMPETITIVE ADVANTAGE
GMCR seems to have an enduring competitive advantage within the home coffee maker market, of which none of their industry competitors have been able to match. This advantage is especially marked by their partnerships with worldwide coffee manufacturers like Starbucks, and the dominating shelf presence in stores. Their products are placed visibly in most major department stores nationwide. Consumers expect to see Keurig machines when they’re in the home appliances section. Considering hardly anyone knew what a Keurig machine was five or six years ago, this is a major branding accomplishment. Partnerships
Building off the strength of the partnerships just mentioned, one of GMCR’s advantages is that they’ve made partners out of the companies that could potentially be threats to them. By carving out a niche that allows them to benefit companies that have the potential to outperform them with their superior capital reserves and global operations, they ensure their viability over the long term. On the other side of the coin, these partnerships allow the company to offer more brands of K-Cups and Vue packets than they would ever be possible to sell by themselves. If Keurig only offered a few varieties of coffee, consumers might tire of the machines or worse, see no reason to purchase them in the first place.
GMCR also has First-mover advantage when it comes to single serve at-home coffee products. First-mover advantage is the edge gained by the initial (‘first-moving’) significant occupant of a given market segment. This advantage came from GMCR’s ability to capitalize on this initial exploitation of the market. Often times companies aren’t able to truly turn this advantage into shareholder value like GMCR has. They’ve done this by positioning the Keurig machine and K-Cups to be the sole product consumers identify with when they think of single-cup brewers. Quality, Convenience, and Choice
Green Mountain Coffee Roasters conducts consumer surveys to further their knowledge of their consumers’ preferences and behaviors. Through these surveys the company has learned three core reasons why they enjoy Keurig? brand coffee over our many competitors. 1) Quality – Within recent years the general public has increased their expectations in regards to the quality of the coffee they wish to enjoy. By utilizing the Keurig system, customers know that they will get quality, consistently produced coffee every time. 2) Convenience – The Keurig system produces beverages in one minute at the touch of a button. In comparison to various methods including drip coffee and French press, this saves a lot of time and hassle. 3) Choice – Due to licensing agreements and our own strong product line, GMCR offers more than 225 individual varieties of beverages. This allows customers to continually explore and enjoy new products. In addition to their many varieties of coffee and tea, they also produce and sell hot apple cider, iced teas, iced coffees, iced fruit brews, hot cocoa and other dairy-based beverages, all in convenient single-serve packs. GMCR’S GROWTH PROSPECTS
National Sanitation Foundation (NSF) Approval
On May 02, 2013, Green Mountain Coffee Roasters, Inc., (NASDAQ: GMCR), announces its Keurig® K150 Series Commercial Brewing System has been certified by the National Sanitation Foundation (NSF) for foodservice use. This is the first small to medium capacity Keurig® brewing system to be certified for the use in foodservice industry. The foodservice industry represents about 65% of coffee purchases outside the home coffee brewing industry therefore to become NSF certified was an important step in meeting the needs of the consumers in this marketplace. Starbucks/Tazo Tea Strategic Partnership
On May 08, 2013, Starbucks Coffee Company (NASDAQ: SBUX), the world’s largest coffee retailer, and Green Mountain Coffee Roasters, Inc. (NASDAQ: GMCR), a leader in specialty coffee and coffeemakers, have signed an agreement that provides for the expansion of their partnership for the manufacturing, marketing, distribution, and sales of Starbucks and Tazo branded single serve packs for use in GMCR’s Keurig® single serve brewing systems globally.
Starbucks and GMCR first entered into partnership in March 2011 where they shipped over 850 million Starbucks® coffee K-Cup® packs. The new 5-year agreement announcement today is a global single-serve coffee industry game changer. Starbucks will add brands and varieties to the already strong Starbucks, K-Cup, and Vue pack offerings for the Keurig® single cup brewers. The new brands will include, Seattle’s Best Coffee®, Torrefazione Italia® coffee, Teavana® Teas, and Starbucks® Cocoa. Snapple Partnership
On May 15, 2013, Green Mountain Coffee Roasters, Inc., (NASDAQ: GMCR), and Snapple have announced the launch of three varieties of Snapple® K-Cup® packs for Keurig® single cup brewers. The arrival of the new Snapple® K-Cup® packs includes the release of Peach Iced Tea, Lemon Iced Tea, and Raspberry Iced Tea. The new varieties join the current Brew Over Ice collection, an innovative line of beverages that are specifically crafted to brew directly over ice with any Keurig® brewing system. SWOT ANALYSIS
Beverage Choice Options
GMCR is one of the preeminent specialty coffee companies in North America. They sell over 200 high quality drink selections. This vast array of beverage choice options allows the company to cater to vastly different consumer tastes. No other home beverage company can compete with GMCR when it comes to the variety of quality coffee options they offer for the home brewing market. Sustainability Image
The company also has a highly venerable corporate image based around sustainability initiatives. Corporate sustainability has been a buzzword in the past few years, to the point where many companies have been accused of ‘green-washing’, or exaggerating their commitments to minimizing the negative externalities their company’s operations have on the planet. GMCR has been doing this since the inception of the company, and it shows that it’s not just a gimmick. This adds great economic value to the company by reducing the chances for an environmental PR disaster. Keurig Business Unit
Another strength is the company’s Keurig business unit, which contributes to
extremely strong revenue growth. As mentioned earlier in the Businesses Unit Section, GMCR recognizes royalty income when a third party ships any Keurig products. The KBU recorded at increase by $494.6 million to a total of $1,683.3 million–A percentage raise of 42%. Weaknesses
Single Supplier for Keurig Machines
As with any other major company, GMCR has inherent weaknesses, which could lead to questions about their ability to minimize operational volatility. For instance, GMCR depends on a single supplier for their single-cup brewer in China. This over-dependence on a single-entity exposes the company to supply disruption risks. This negative impact would harm their ability to acquire new customers for their K-Cups, which is how the company makes most of their profit. Single Order Processing Partnership
GMCR also relies on a lone order fulfillment business, M.Block & Sons (MBlock), to process most of their orders for at-home single-cup business they sell through retailers, department stores, and mass merchants in the United States. Their partnership with MBlock exposes the company to “significant credit risk regarding the creditworthiness of MBlock”. Net receivables from MBlock accounted for 41% of GMCR’s consolidated receivable net balance. If MBlock for some reason is unable to fulfill their obligations to GMCR, this could equate to significant losses for the company. Therefore, reliance on single entities could increase business risks for GMCR. OPPORTUNITIES
Current opportunities they have via collaborations with other companies are happening constantly and frequently. Since the beginning of May 2013, the company signed an expanding 5-year partnership with Starbucks, which has had a positive effect on their share price, driving it towards a 52-week high for the week ending May 10th, 2013. This agreement will triple the branding items made for GMCR’s Keurig brand. Starbucks CEO Howard Schultz speaking on CNBC said, “We’re going to do everything we can to promote the Keurig system and obviously Starbucks K-Cups and this is going to be a significantly lucrative deal for both companies.”
On May 16, 2013, GMCR and Snapple introduced three varieties of Snapple K-Cup packs, including Peach Iced Tea, Lemon Iced Tea, and Raspberry Iced Tea. This should help the company expand their sales outlook for summer with cold beverages with a major brand name. The public perception is that Keurig is mostly a hot coffee and tea product manufacturer. This line of “Brew Over Ice” beverages will help expand both companies’ presence in homes and offices during warm summer months. International Expansion
In Q4 of 2012, GMCR entered into an agreement with Gerard Geoffrion (formerly the head of their Canadian Business Unit) to become the company’s President of International Business Development. In this new role, Mr. Geoffrion will head the corporation’s exploration of business expansion opportunities outside of North America. The company has yet to make any formal announcements about decisions to offer their products outside of North America but with so much untapped consumer power in Europe, South America, and Asia (especially BRIC economies), the opportunities for careful expansion into these markets remain a powerful untapped source of growth for the company. Entry Into Functional Drinks Market in the U.S.
The functional drinks markets—energy drinks, sports beverages, and nutraceutical drinks (dietary supplements) is a $7 billion market. This market is expected to grow at 10% per annum until 2016. GMCR has only recently declared its intentions to exploit this market. If the company were able to leverage its extremely strong brand image into this market and become an accepted name it would definitely create new opportunities for revenue growth. THREATS
Highly Competitive Specialty Coffee Market
GMCR encounters stiff competition in the specialty coffee market. It faces sellers of specialty coffee including Starbucks, Peet’s Coffee & Tea, and Dunkin Brands. They also face tough competition in the consumer direct channel, with brands such as Nestle (who markets the premium Nespresso single-cup espresso system), Gevalia–a well-established roaster and division of Kraft Food, and other direct mail companies. In the food service
industry, they face off against “private label” roasters, along with large brands like Seattle’s Best Coffee (a subsidiary of Starbucks). Other single-cup coffee and tea system makers such as Mars, Bosch, Philips, and Sara Lee crowd the markets in which GMCR operates. Inability to Patent Roasting Methods
GMCR is unable to patent their roasting methods. This leaves them unable to keep their competition from stealing their roasting processes if indeed they were to leak to the public. If these methods were copied it could have a significantly detrimental effect on the value of their brands. Additionally, their competition could also expand on these methods to make them more advanced than GMCR’s. This would have a direct and negative effect on their competitive position relative to the industry. SEC Investigation
Another weakness that could affect brand image is an ongoing investigation by the Securities and Exchange Commission (SEC) for certain aspects of their revenue recognition practices and their relationship with one of their vendors. The investigation has to do with how and when revenue was recognized between GMCR and MBlock. While the SEC hasn’t charged anyone at GMCR with any wrongdoing, they’ve had questions in the past about how their accounting processes work. Manufacturers are able to use their distributors to “improperly boost revenues by making shipments to and from their warehouses at inappropriate times”. They do this to be able to record higher earnings by recognizing revenue before a product is actually sold to consumers. GMCR defends their revenue recognition practices, but formal charges could certainly do major damage to shareholder value. Decreased Availability of Arabica Coffee Beans
In order to produce over 100 different types of coffee selections, GMCR roasts at least fifty different kinds of coffee beans. If there were to be a supply-side shortage of these beans worldwide (as some market analysts consider a major possibility as some point), this would have a devastating impact on the company’s ability to maintain their operations. The Arabica beans they roast aren’t sold directly on the commodity markets. Instead, they have to rely on coffee brokers, exporters, and coffee farmers to
constantly supply this primary raw material. Coffee beans that are Fair Trade Certified are especially limited. These price fluctuations are generally passed on directly to consumers, and specialty coffee is considered as being price elastic. If prices were to suddenly and drastically increase, demand would be lowered. Inversely, if prices were to rapidly decrease, GMCR would have to lower their prices and this would result in smaller profit margins. Therefore, fluctuations in raw material costs could threaten GMCR’s potential to maintain or expand their business. FORECAST ASSUMPTIONS
What we have learned about GMCR is that the company is in a rapid growth stage. In recent years, as the Keurig system gained in popularity GMCR’s sales revenue has grown from $500.28 million in 2008 to an incredible $3,859.20 million in 2012. That is a 671.4% increase in sales revenue in just 4 short years. To explain this astonishing growth, all signs point to the rapid adoption of the Keurig system by consumers in North America. The Keurig single-cup brewing system was first launched in 1998, but the company was fully acquired as a wholly owned subsidiary of GMCR in 2006. GMCR entered into partnership with Starbucks in March 2011, shipping more than 850 million Starbucks coffee K-Cup packs throughout the region within 9 months. The same year, in 2011, GMCR had a 95% increase in sales revenue from the previous year of 2010. In May 2013, Starbucks and GMCR signed an agreement that provides for the expansion for their successful partnership for the manufacturing, marketing, distribution, and sales of Starbucks and Tazo branded K-Cup packs for the use in GMCR’s Keurig system globally. This announcement recognizes the mutually beneficial opportunities both companies have to broaden their success by extending their partnership. After taking into consideration the risks the company could face in the future, their historical performance, their current business environment, and their competition we were able to make the following assumptions: Sales Growth Rates
The graph below represents the historical sales growth from 2008 to 2012 and a continuation of projected sales revenue growth from 2013 to 2022. Figure : Sales Revenue Growth Rate
As shown in the graph above we expect GMCR to continue to show an increase in growth but at a decreasing rate moving forward in relation to what they’re currently experiencing. Based on the historical sales growth rates as shown in Table 1 below, we know that GMCR is in an unusual and extremely high growth stage between fiscal years 2009 through about 2011. Table : Actual Sales Growth Rate CY’08-CY’12
This unusually high growth rate is due primarily to the popularity of the Keurig system and a signed contract with Starbuck as mentioned earlier. In 2012, the growth rate had significantly gone down from 95.4% to 45.6%. We assume that a sudden increase in popularity will only happen once, and that primarily occurred between 2009 and 2011. Moving forward, we predict the growth rate of the sales revenue will steadily decrease in the coming years.
As shown in Table 2 below, and beginning with a 40% growth rate in 2013 we have forecasted the sales growth rate to steadily decrease by 5% each year until year 2020, and stabilizing at 5% until the fiscal year 2022. Based on historical data, GMCR has had a steady net sales growth rate averaging around 17.5% from years 2003 to 2005, before the Keurig system had been fully acquired by the company. We believe that GMCR will continue to show an increase in sales–just not at a rate of 60% or higher. We do not expect these kinds of extremely high growth rates due to the competitive environment, the patent of the Keurig system ending in September 2012, and new competitors that will continue to emerge in the coming years. Table 2: Forecasted Sales Growth Rates
Green Mountain Coffee Roasters’ projected profit margins average around 9.4% from years 2013 to 2022 in comparison to 6.8% historic average from years 2008 to 2012. The profit margins are expected to be slightly higher than previous years due to an increase in K-Cup sales as GMCR continue to expand the varieties of their beverages. The forecasted Profit Margins are expected to remain near 9.0% as shown in a graph below. Figure : Profit Margin Actual CY’08-CY’12, Forecast Projection CY’13-CY’22
Asset and Liability Growth
In the period between 2009 and 2012, total operating assets and spontaneous liability growth rates are similar in growth to each other. These rates show a similar pattern as the sales growth rate. Therefore in the forecasting years we were able to project that operating assets and spontaneous liabilities will have the same rates as the forecasted sales growth rate. Figure 4 below shows this relation. Figure : Relationship of Operating Assets and Spontaneous Liabilities to Forecasted Sales Growth Rate CY’09-CY’22
Included in our list of items that will not grow in the forecasting years are intangibles, other assets, notes payable, and accrued expenses, deferred taxes, common stocks, and capital surplus. Cash and cash equivalents is a non-growth item but is based on the AFN (Additional Funds Needed) value. Constant Growth
All items on the Income Statement and the Balance Sheet (with the exception of non-growth items mentioned above) will have a constant growth of 5% between the years 2020 and 2022. We predict a steadily decreasing growth rate starting with a rate of 40% in 2013, decreasing by 5% each year until the year 2020 (where the growth rate is projected to stay constant at 5% through year 2022). Dividend Payout Ratio
Green Mountain Coffee Roasters has never paid dividends to their shareholders. Based on this (and from management notes in the company’s 10-K), we can assume that GMCR will continue to not pay dividends in the foreseeable future. Miscellaneous Assumptions
The average interest rate on debt, also known as the cost of debt, is assumed to remain constant at 3.7% between the years 2013 and 2022 (GMCR 10-K, 2012). The company’s tax rate is assumed to remain constant with previous years at 36.9% (also in GMCR’s 10-K). Property, plant, and equipment growth is assumed to be 20% for year 2013 and 10% for the
remaining forecasted years 2014 to 2022. We have based this assumption on the fact that GMCR will not have the need to build or purchase additional property, plant, or equipment by much after this year. The only growth would be if the company plans to expand its operation on an international level. While it is probable that they will undertake international expansions, no such plans have been formally mentioned. FORECAST RESULTS
After these assumptions have been implemented we estimate GMCR will recognize sales of $5.4 billion and control total assets worth $4.2 billion in fiscal year 2013. Estimated net income will be approximately $500 million with no dividend payments. Since GMCR has not paid dividends in the past and did not mention any plans to in their most recent 10-K, we have decided not to include future dividends. Thus, our addition to retained earnings grows by approximately $500 million to a total of $1.78 billion. Since this increases our total assets (but not our total liabilities) proportionally, we see that we need $27 million in Additional Funds Needed (AFN). To balance this figure we need to decide if it is appropriate to use debt or equity to cover the AFN. Debt vs. Equity
To adjust for AFN we need to understand how GMCR was financed in the past. Table 3 shows us that both debt and equity have been used for growth; however, since debt can be sourced at a very low rate of about 3.7% we have determined this is the appropriate figure to use for the AFN. GMCR is not rated on Moody’s or Standard and Poor’s. Accordingly, we have referred to the GMCR 2012 10-K for the estimated future cost of debt. Since we only need additional financing in 2013 we have used cash as the balancing figure when AFN is negative.
Table 3: Debt and Equity Used for Growth
Long-term Outstanding Debt
Source: 2012 GMCR 10-K
Additional Funds Needed
According to our forecast, GMCR needs to issue additional debt for fiscal year 2013. With such a low interest rate on debt, it makes it attractive for GMCR to utilize corporate bonds at this time. Figure 5 looks into the AFN for the next 10 years as the company grows proportionately. As you can see, in years 2014-2022, the AFN is negative. This is because total liabilities and equity is greater than total assets. This means that there is a capital surplus. These funds have been added directly to the cash and cash equivalents account. We feel like this is the best course of action because GMCR is in such a great growth phase that any extra capital can be used to invest in future projects and help the company grow further. Another option would be to pay back the debt, but with such low interest rates, we see it better fit to invest the money.
Figure 5: Future Additional Financing Needed
Debt to Equity Ratio
GMCR has a relatively low debt-to-equity ratio. Figure 6 looks at the historical liabilities to equity and future predicted ratios with a 0.96 in
2010 dropping to .19 in 2022. With this future outlook GMCR should have no problems managing its debt levels and paying off interest expense. Figure 6: Debt to Equity Financing Ratios
With our forecast and the GMCR income statement and balance sheet, we have calculated Free Cash Flow to Equity as depicted in Figure 7 below. The projection begins with $136 million in 2014 and eventually finishes at $1,492.86 million in 2022. Based on this our FCFE is the same as our AFN, which means that all the available funds are reinvested back into the firm and no dividends are paid out. Figure 7: Forecasted Free Cash Flow to Equity
COST OF CAPITAL
To figure out the value per share, we must first find the cost of capital for GMCR. To get this, we need to examine three different components: beta, which is the firm’s measure of risk, cost of equity, and the cost of debt.
To calculate an accurate beta for GMCR, we employed a couple of different methods. First we used the top-down approach or regression analysis. Next we used the bottom-up method. Finally, we used some outside sources such as Yahoo Finance and Google Finance. With these sources and calculations we came up with a final beta of 0.89. Initially this seemed fairly low, but we felt confident it would work in our cost of equity calculation. Bottom-up Beta
To calculate a bottom-up beta we used Aswath Damodrans website. Table 4 shows us the results and numbers used to find the beta estimation. Table 4: Values Used in Beta Calculation
Bottom-Up Beta Calculation
Number of Firms
Industry Average Beta- Levered
Industry Tax Rate
Industry Average D/E
Industry Average Beta-Unlevered
GMCR leveraged D/E (market)
GMCR tax rate
Source: Aswath Damodaran
Top-Down or Regression Analysis Beta
For the top down beta, we ran a monthly and weekly regression analysis based on 262 weeks and 60 months of historical data comparing the GMCR to the NASDAQ Stock Index on which Green Mountain Coffee Roasters stock is traded. The 60-month beta was calculated to be 1.05 and the 262-week beta equaled 1.01. Table 5 below shows the lower and upper 95% confidence intervals. As you can see they are very far apart so we found the top down beta to be unreliable. Table 5: Beta with Lower and Upper 95% Confidence Intervals Time Period
Final Beta Estimation
To find our final beta we used a variety of sources and weighted them according to their validity. We placed the most weight (30%) on Reuters and our monthly regression analysis. Table 6 below shows the rest of the weights and the final beta. Table 6: Weighted Average Matrix Beta Calculation
Cost of equity
To find our cost of equity, there are several factors that need to be included: the equity risk premium, beta, and the risk-free rate. The equity risk premium was located using Damodarans website. It is the geometric average of return on stock and T-bonds from 1928-2012. For the risk-free rate, we used the 30-year Treasury note rate of 3.20% (Bloomberg 5/18/2013). To get the Cost of Equity we apply the Capital Asset Pricing Model (CAPM). Using the weighted average beta of .89, we get a cost of equity of 8.35%.
Cost of debt
The cost of debt (Kd) was taken from GMCR’s 2012 10-K. In this 10-K there is an estimated Kd of 3.7% based on future hedging and variable rate fluctuations.
The final result of GMCR’s valuation is $108.50 at a cost of equity of 8.35%. The current market price was $76.09 at the close of trading on June 7th, 2013. Table 7 below summarizes the values used in calculation the value of GMCR. Table 7: Values used in Valuation Calculation
Based on our valuation, the current stock price of GMCR is undervalued by approximately 30%. There were many assumptions made throughout our valuation process. Most importantly, the first reason that our valuation shows a higher value than the price stated on Yahoo Finance is because we took on a conservative approach of an assumed cost of equity. GMCR has experienced rapid growth within the last few years and might be approaching the maturity stage of the business lifecycle. With such rapid growth already shown, it is possible that investors are expecting future large growth rates as well, thus putting very high expectations on GMCR. Whenever a company is in a rapid growth state it is safe to say that the company is at a much greater risk of not generating future cash flows to the same extent. By choosing to use 8.35% cost of equity, we believe this to be a conservative approach of valuing the market price of a company that is currently in a high-growth stage. The second reason why the value of $108.50 might be more accurate is
that the market expects GMCR to continue to show steady growth. With a recently signed agreement to extend the partnership with Starbucks, there can be an expected continuation of successful growth. Additionally, GMCR has contracts with many different coffee makers to market and distribute their branded K-Cup packs for the use in their Keurig systems. With a large present value of growth opportunities in expending the Keurig and K-cup brand, GMCR has the potential to show steady growth for the next few years. To offset our findings, we used two other costs of equity to show the differences in the market value price of GMCR with other potential costs of equity. Table 8 below shows a comparison of the market value using a higher cost of equity. Since Cost of equity (Ke) is a very uncertain number, we saw it fit to use higher Ke in case GMCR could not effectively acquire capital at 8.35%. At a Ke of 9.5%, a market value of $85.04 closely resembles the actual price per share on 5/21/2013 of $80.01. Table 8: Value Per Share at Various Ke
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