PEET – EXPENSIVE AND BUILT TO STAY THAT WAY

PEET’s is one of those rare small cap companies that is well managed and operates within a strong category.  Its current valuation partially reflects the coffee bubble that is being priced into several names within the coffee space.  PEET takes the prize for the company with the highest inflation rate at 40%.  During the past quarter coffee prices have declined almost 20% during 2Q11.  It is likely that gross margins erosion peaked this quarter and should mitigate going forward barring a spike in coffee prices.

 

The following comments are the forward looking statements from the 1Q11 earnings call which took place on 05.03.2011 as well as our take on certain topics.

 

GROCERY TOP-LINE: “Looking forward we have good momentum in our grocery business. We have strong base plans in place, very good visibility on the new distribution we expect and some things later in the year that we expect to have a meaningful impact on our business.”

 

“Grocery growth of 22% in the first quarter on top of last year's 39% growth in the first quarter was strong and reflects the overall health of this business, the strength of the brand and superior execution capability of our DSD system.”

 

HEDGEYE: The growth in grocery was achieved despite the price increase not being in effect for the full quarter.  The overwhelming majority of the company’s growth came from existing store distribution.  Late in the first quarter, Peet’s added “200 to 300” targeted stores.  The company was at roughly 9,000 at the end of 2010 and plans to add 1,000 to 1,500 in 2011 and maintains that it has “very good visibility” on that target.  As the DSD business is expanded, we expect a significant boost to margins given the degree of operating leverage in this business model.

 

 

RETAIL TOP-LINE:  Retail sales grew 4% in the quarter, all from existing stores.    

 

HEDGEYE:  Going forward, Peet’s has a number of top-line and efficiency initiatives coming through that should maintain or improve on retail performance notwithstanding rising coffee costs.  By the end of 2Q11, a new labor and time management system will be rolled out which will enable the company to more effectively schedule labor needs.

 

 

OTHER TOP-LINE:  Foodservice and office business grew 11% in 1Q11 and lowest rate of growth this year given the timing of new licensed locations, and the fact that a price increase in early January spurred some stronger orders back in December of 2010.

 

HEDGEYE: The rate of growth in 1Q11 will be the low point of 2011 and I expect trends to accelerate in 2H11.

 

 

MARGIN TRENDS: “In the specialty segment margins should continue to improve”… “In 2011 have turned the corner and are starting to see the operating leverage as put more volume on the existing DSD system” … “In 1Q11 G&A expenses improved 10 basis points over last year and there should continue is leveraging this line item for the rest of the year.”

 

HEDGEYE:  In terms of the expenses the company can control, we think it has managed them well.  The quotes above and tone of the conference call showed confidence in their ability to gain on the margin line though operating leverage.

 

COFFEE COSTS: “Coffee has gone from 15% inflation when we set our plan back in November of 2010 to 30% at our last call on February to over 40% now in May as the market has breached $3. Higher coffee costs will begin to significantly impact gross margins in the second quarter. In fact, the largest quarter-to quarter jump will occur between the first and second quarter. In Q1, our hedging benefits limited our coffee increase to 14% higher than last year. We began locking in more expensive coffee in the fourth quarter of last year and first quarter of this year and we'll start using that coffee this quarter.”

 

“Were expecting our full-year inflation to be around 40% in coffee costs”

 

“As a result, whereas gross margins were down only 40 basis points in Q1, we expect gross margins to be down in the 300 to 400 basis point range for the balance of the year.”

 

“Net-net we will be able to offset most of the short term coffee cost issues we have with operating expense savings and leverage of other costs, but we will continue to invest in areas for longer-term business benefit, and therefore, not expect to offset the full amount this year.”

 

HEDGEYE:  Coffee is the big wild card for this company but, in our view, the company is doing all the right things to reap significant benefits if/when coffee costs mitigate.

 

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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