Monday, September 19, 2011

Investors are getting roasted with JVA

As many coffee aficionados may know, Coffee Holding Co. (JVA)  has a vital interest in the success of Green Mountain Coffee Roasters (GMCR). As GMCR's shares climbed the green mountain, the Sherpa of JVA has joined for the ride.  See JVA's chart below.

However, we strongly believe that JVA's shares are overpriced (P/E: 31x) and its business risks are High...Not a good Brew!   Below are our Top reasons to avoid these shares:

1.)  Coffee Holding Co. is a distributor.  Distributors trade at very low price-to-earnings and price-to-sales multiples.  By their very nature, distributors grow only as fast as the market.  Additional "growth" is usually attributed to rising prices (rather than true volume gains) or acquisitions.   JVA has done both, which has positively affected revenue growth.  Hence, its shares should receive no premium for that growth.  According to the latest data from research firm StudyLogic, Coffee demand in the U.S. rose just 2% during the 12 mos ended June'11.  Though, in fairness to JVA, this growth was driven by K-cup demand (Green Mtn.'s product).  The table below includes P/E ratios for several types of businesses.  The bar chart shows historical US coffee demand, which we estimate grew <2% yearly since 2000.  The last chart shows the sharp gains in coffee prices over the last year.

 Coffee Futures (KCU11)
2)  JVA is a complimentor to Green Mountain Coffee (GMCR).  However, this is not a case of "Wintel" aka Microsoft and Intel, in which both companies equally benefited.  First, GMCR benefits more so than JVA because a) it commands and controls its own K-Cup ecosystem.  However, JVA is simply a distributor with no proprietary technologies; no entry barriers.  JVA does not have a trade-pact with GMCR, meaning GMCR could drop the company at will (with no consequences).  Secondly, GMCR benefits because it is a manufacturer of the (proprietary) Keurig system, which entails significantly higher profit margins.

3). We believe GMCR may be using aggressive accounting.   The Securities & Exchange Commission continues to investigate GMCR's accounting and internal controls.  This SEC inquiry was initially reported in GMCR's Form 8-k link of September 28, 2010 and remains ongoing.  Further, the company noted in its 2010 Form 10-K annual report link (Item 9A - Controls and Procedures) that there are "material weaknesses in its internal controls related to financial reporting."  Should any negative headline news occur, GMCR's business would suffer, which could directly impact JVA's business, as well as investor sentiment across the entire coffee industry.  As a background, readers may be interested in this author's articles Dominic Lombardo and Sam Antar's on GMCR.

4.)  JVA is aggressively trading in the coffee derivatives market, which the company states is used for hedging price volatility.  However, we note that a) a large portion of its (green) beans business cannot be hedged directly, thus creating cross-hedging risks, b) company is trading near-term options (which easily lose time-value),  c) the dollar amounts are large, including what has been mostly trading gains.  In good times, this creates the illusion of core profits.  

The Income Statements below are for FY'09, FY'10 and 2Q'11.  They include adjustments (i.e, hedging profits are taken out of reported numbers).  FY'09 adjusted numbers also exclude a non-recurring gain of $2.1mm.  This results in 36% and 73% lower EPS for FY'10 and FY'09, respectively.  2Q'11 adjustments resulted in 69% lower EPS.  Under the "% Change" column, is noted how the adjustments affect the Balance Sheet and Cash Flow Statements.

In bad times (i.e, when management makes "wrong-way" bets) reported earnings could decrease significantly (as in the most recent quarter, see below).

5).  Financial Leverage is increasing.  Debt/Capital rose from 14.6% during FY 10/2010 to 32.9% during the latest quarter (7/2011).  This percentage also includes margin loans from its derivatives broker.  See red highlighted below. Management recently (9/14/11) filed an S-3/A link in what is called a "Shelf" registration for a huge dollar amount of $100mm in Debt, Equity and other securities.

6). Shareholders have little say in JVA.  Brothers Andrew and David Gordon control the executive positions of the company including President, CEO, CFO, and COO.  The company has no "key-man" life insurance for either brother.  This is a family business with the extended family owning nearly 49% of JVA's shares.

7).  Lack of Internal Controls:  Given the nature of the business (i.e., small, family-managed, lack of a Big 4 accounting firm) controls are somewhat deficient.  For example, JVA recently filed two amendments with the S.E.C.- the first was an amendment to the Form 10k annual report.  The second was far more serious, an 8-K essentially reporting that there was a leak of the firm's recent quarterly earnings release (for July'11).  Consequently, it was necessary for the company to issue preliminary earnings.
Source: Coffee Holding Co, 8K, Aug. 30, 2011
8.) Numerous Conflicts-of-Interest.  A) One conflict this author has never seen is the linking of brokerage reports on JVA to its website (link).  Typically, companies tell investors which Street analysts are following it, letting investors attain the reports themselves. An example (Starbuck's) is provided here.  B) Further, the company does ("arm's length") business with its 40% partner (Generation Coffee Company LLC).  Refer to Item 13 of Form 10-K/A for FY'10 for additional information.

C)  JVA director Daniel Dwyer, is a coffee trader at Rothfos Corporation- a coffee bean supplier.  Mr. Dwyer is also responsible for a large account between the two companies.  Refer to Item 13 of Form 10-K/A for FY'10 for more information.

We have not seen evidence JVA is using aggressive accounting or misusing its relationships.  We also believe the company is correctly accounting for its hedging program as per IAS 39.  However, they're just too many risks (e.g., dependence on GMCR) to justify its high share price

Disclosure:  The author has no investment position in JVA (short or long). The author does not receive any monetary or implicit dollar benefit from this article.

Sunday, September 18, 2011

Market Indicators turn Bullish

Sentiment Indicators and Technical Indicators turn Bullish:

Note: Click here for latest reading..

Both sets of Indicators turned Bullish.  Technical Indicators reach the highest levels in over a decade. 

However, we would caution from investing very high proportions into equities and bond markets as Fundamentals remain weak.  While we believe a U.S. slowdown is already factored into equities prices, the Euro-Crises has yet to see a resolution.  We believe the European Central Bank and other authorities will work on yet another "bandage" and short-term fix, with the best fix being Euro-Bonds.  However, this will not solve the European budget and economic problems.

We believe a good time to increase positions will be the next time Panic sets in.  This will likely occur in the next few weeks, based on historical ebb-flow of Euro-news.

Sentiment Chart is below:  It became bullish when the index surpassed 7 in mid-August'11.

Technical Chart is below.  It became extremely Bullish in August as well.

As a long-term investor, I believe the time for Socially Responsible Investing is now…right NOW.  Long-term investors are not concerned over the current level of the stock market and whether the Market’s going to rise or fall the next day.

I propose investors be “fully invested” in equities most of the time.  Being “fully-invested” is different for different people depending on age, risk tolerance, etc.  As a Heuristic, I suggest being 75% long equities as a “base-case” level.  The remainder would be invested in bonds, real-estate, hard assets, and alternative/exotic investments (e.g., natural gas, platinum, rare-earth anyone?).

With that being said, there are certain times that are better to invest in the market.  Rather than choosing tops and bottoms based on certain fundamental criteria (e.g. price to earnings ratio), I have developed two Market Timing Indicators.  These indicators help me maintain objectivity with regards to my investment positions, as I have no influence on them.  They were designed during late 1992 and have been updated weekly since.

The two major indicators are:

1.    Sentiment:  based on human behavior, and supported by theories backed by Behavioral Finance. 

2.    Technical:  which measures market breadth, or underlying strength in the broad market.

These indicators are used to obtain my Portfolio's Investment Position.  Note, they do not know, or represent market levels.  They are measures of perceived risk, especially the Sentiment Indicators.  I have often taken mental notes of how everyone seems to clamor to buy things when their expected rate of returns are minimal compared to their inherent risks. 

This website will include three simple colored (traffic) signals.  Green for “Buy” (i.e, low-risk levels) which means allocate your portfolio to a fully-invested equity position.  For me, that’s about 75-80% invested, but it could be lower for a more-risk adverse, or retired individual.  Yellow, means caution, risk levels rising.  Red means “High-Risk”; investors should reduce their investment positions to conservative levels perhaps 30-40% equity.  The remainder could be in treasuries, gold, high-grade corporate bonds, etc.

Monday, September 12, 2011


INVESTING FOR CHANGE:  Profit from Responsible Investment
by Augustin Landier, Vinay B. Nair
copyright: 2009, Oxford University Press

Just started reading Investing For Change - actually, just finished reading it too.  I was drawn to this book for a few reasons:
  • The book is a quick read, but the authors have a substantial body of knowledge to pull from.
  • Authors have "hands on" experience in the investment management business, and they aren't just theorists
  • Back of the book has an Appendix and, several pages of biographies for its footnotes.

Best For:
  • Individual investors (uses little math)
  • Investment professionals (though limited in scope)

 What I liked:
  • I liked the historical background of SRI and the way the authors tied this with global investing trends (this info is difficult to synthesize from the gobs of texts on the Internet).

What I didn't like:
  • The last chapter was, to put it simply, confusing, complex and poorly written.

Biggest Surprises:
  • Hadn't realized how pivotal SRI was towards ending apartheid in South Africa.
  • Increased Self-Awareness: hadn't realized how aligning ones values w/ investments would make oneself more authentic (as in Existentialist Philosophy).
    • Authenticity is the degree to which one is true to one's own personality, or character, despite outside influences.

    Our Notes:
    The authors use sharp analogies to grapple around an investing concept that could be confusing not only for novice investors but experts alike.  Today, professional pension fund managers are battling their consciences to determine whether SRI is even legal under ERISA (Employee Retirement Income Security Act of 1974) and the infamous Prudent Man Rule.

    While superficially simplistic, the authors' intellectual curiosity shine with their pragmatic questioning of Socially Responsible Investing.

    They ask, for example, "Is it really possible to express our moral values through our investments?" 
    • "Does SRI imply taking more financial risks"
    • "Does SRI force less virtuous companies to improve their behavior?"
    One of my favorite analogies utilized was describing how the motives for various responsible investors are different.  The authors compare the different motives for vegetarians with that of SRI.  For example, some vegetarians are motivated by health reasons, others do not want to be accomplices in the killing of animals.

    Similarly, some investors avoid "sin stocks", others seek investments in responsible companies, so long as they don't limit financial returns that much.  And still others, are using SRI as a quantitative metric to boost returns.  The latter has no morality involved.  The authors then go on to answer the questions mentioned above.

    This "quick-read" has an interesting take on SRI.  Though, may leave some readers asking for more as the authors breezed over certain points.

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