Consumer Sector Ideas

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Green Mtn Coffee, Herbalife -- >>> 2 Einhorn Shorts to Short

By David Gould

November 30, 2012


http://beta.fool.com/takeoveranalyst/2012/11/30/2-einhorn-shorts-short/17727/?ticker=GMCR&source=eogyholnk0000001




Value investor David Einhorn has been successful targeting entrenched management before and shaking up the status quo to unlock value. However, of late, he has targeted the wrong companies--those that have succeeded despite challenging macro conditions. His short theses have crashed company valuations in the past, sometimes from speculation alone. While these attacks have netted Einhorn millions, it has opened up the opportunity for you to create wealth through just the opposite approach. Below, I review two companies that he wrongly targeted.

Green Mountain Coffee Roaster (NASDAQ: GMCR)

This well known Einhorn short fell from a high of $110 to a local low of around $17.50. It has since recovered to $25.15 but, in my view, remains incredibly undervalued. First, the company is cheap probably by anyone's standards on a multiples basis. It trades at a respective 11.7x and 10.1x past and forward earnings with a PEG ratio of 0.67. Second, it has delivered 75.4% annual EPS growth over the past five years. By contrast, competitor Starbucks (NASDAQ: SBUX), which trades at 28.9x past earnings, has only grown EPS by a rate of 5.4% during the same time. While the analysts continue to expect GMCR to outperform by around 200 bps more per year, this is not nearly optimistic enough for several reasons.

First, Starbucks has made a name for itself by saturating the market. The question that naturally follows but seems to not be asked is: How much penetration potential is left? Whereas Starbucks has few growth opportunities, as I see it, in the specialty coffee market, it has plenty of headwinds. The entrance of McDonald's in the grocery coffee market will pose a secular margin pressure on Starbucks in its attempt to stay, or even elevate, demand for higher-price coffee. GMCR, however, is just getting started in penetrating new markets. I thus strongly encourage buying GMCR over Starbucks. It should not be surprising then that GMCR has outperformed expectations by a higher average amount (36.3% vs. 2.4%) compared to its competitor.

Going forward, I anticipate strong returns for GMCR. The company recently made a deal with Costco that will help the company increase leverage towards a recovering economy. In the deal, Costco will carry single-serve coffee pods for the Keurig brewing system with a goal to sell the items by December. Shorts are starting to cover while people are becoming more encouraged about the single-serve market allowing for multiple competitors.

Herbalife (NYSE: HLF)

Herbalife is perhaps the most famous Einhorn short in recent months. In the company's earnings call, the well known short seller suggested that the company could be running an illegal pyramid scheme. While the company has recovered from the bear attack, it still remains incredibly undervalued and underestimated. In regard to the pyramid scheme allegation, Lieberman Research has shown that one-twentieth of US households have consumed a Herbalife product in the last three months, and that 90% of those individuals came outside of the distribution network. In order for a company to be getting most of its sales outside the distribution network, it requires, well, real products.

Fortunately, the MLM seller has consistently outperformed expectations over the last five quarters by an average beat of 11.7%. Assuming the company merely meets growth expectations (which I find overly bearish), 2016 EPS will come out to $4.40. At a multiple of 15x, this translates to a future stock value of $66. Discounting backwards by 10% yields a present value of around $41--considerably above the $25.27 current market assessment.

It should be noted how far off the company is from analyst price targets. While Argus recently downgraded the stock from a "buy" to a "hold," Longbow upgraded to a "buy" with a $130 price target. You read that correctly: a price target more than quintuple the current trading price. If the company's strong growth curve and low multiples weren't enough to compel an investment then this should be.

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