UNIVERSITY OF OREGON
INVESTMENT GROUP
January 15th, 2010
Consumer Goods
Peet’s Coffee & Tea Inc.
RECOMMENDATION: HOLD
Stock Data
Price (52 weeks)
Symbol/Exchange
Beta
Shares Outstanding
Average daily volume
(3 month average)
Current market cap
Current Price
Dividend
Dividend Yield
Valuation (per share)
DCF Analysis
Comparables Analysis
Target Price
Current Price
19.29-42.20
PEET / NASDAQ
0.765
13.3M
303,555
= 455M
34.1
-
$27.11
$39.09
$33.10
33.69
Summary Financials
LTM (Thousands)
Revenue:
Net Income:
Operating Cash Flow
$298,700
$13,000
$29,900
BUSINESS OVERVIEW
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
Email: 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.
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
Retail Segment (66% of Total Revenue)
As of December 28th, 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
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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 2014.
Per-Capita Disposable Income:
4
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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 2010. Below is a graph of the projected
forecast through 2015.
Unemployment Level- National
The increased disposable income level seen previously may or may not offset the increased unemployment.
In years 2011-2015 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
MAJOR MARKET SEGMENTS
breakdown of the respective
Market Segment
Share
market segments.
Primarily driving the
Grocery wholesalers
73.2%
Exports
12.4%
revival of the coffee production
Retail trade
10.0%
industry was the changing
Foodservice
industry
2.5%
landscape of consumer dietary
Direct sales
1.9%
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
5
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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 7th 2009 -- 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 15th 2009 -- Peet's Coffee & Tea Announces HSR Clearance in Connection with Proposal
to Acquire Diedrich
•
January 8th 2010 – GMCR extends offer to buy Diedrich.
6
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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 2012.
•
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
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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
2004. 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
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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 2008 10k, and was grown by 2%
10
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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 2012.
2) 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
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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 2008. 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
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
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
$33.10. 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
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 1 – COMPARABLES ANALYSIS
14
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 2 – DISCOUNTED CASH FLOWS ANALYSIS
15
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 3 – DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS
APPENDIX 4 – BETA SENSITIVITY ANALYSIS
16
Peet’s Coffee and Tea Inc.
university of oregon investment group
http://uoig.uoregon.edu
APPENDIX 5 – SOURCES
•
•
•
•
•
•
•
•
Ibisworld
Census.Gov
Peets.com
SEC.gov (PEET 10k’s, 10q’s)
Google Finance
Yahoo Finance
International Coffee Organization (www.ICO.org)
Bloomberg
17