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Mark Lin
Mark Lin
Articles (212) 

Farmer Brothers: Brewing Profits

February 15, 2013 | About:

Founded in 1912, Farmer Brothers Co. (NASDAQ:FARM) is a manufacturer, wholesaler and distributor of coffee, tea and culinary products. It is a direct distributor of coffee to restaurants, hotels, casinos, hospitals and other foodservice providers, and a provider of private brand coffee programs to Quick Serve Restaurants, grocery retailers, national drugstore chains, restaurant chains, convenience stores, and independent coffee houses, nationwide. FARM's product lines include roasted coffee, liquid coffee, coffee related products such as coffee filters, sugar and creamers, assorted teas, cappuccino, cocoa, spices, gelatins and puddings, soup bases, gravy and sauce mixes, pancake and biscuit mixes, and jellies and preserves.

Guru InsightsMichael Price and Mario Gabelli added to their existing positions in FARM with purchases of 31,267 shares and 12,286 shares, respectively, in the fourth quarter of 2012.

Business Quality and Capital Allocation

Since 2007, FARM has undergone a transformation process with the acquisition of Coffee Bean Holding Co. Inc., the parent company of Coffee Bean International Inc., a specialty coffee manufacturer and wholesaler, and certain assets of Sara Lee's Direct-Store Delivery coffee business in 2007 and 2009, respectively. From a West Coast-focused, single-brand traditional coffee distributor known for supplying small operators, FARM now has multiple brands across the traditional, premium and specialty coffees categories with three roasting facilities in Torrance, Houston and Portland, and direct-store delivery distribution in 48 states. It was named vendor of the year for Target Corporation and Einstein Brothers Restaurant Group in 2010 and 2012, respectively, and became the first company not associated with bagels to win the Golden Bagel Award from Einstein Noah.

FARM has a market-leading direct-store-delivery footprint in the country, with an unparalleled distribution network serving multiple segments of foodservice and retail channels. Its customers are served from six distribution centers strategically located across the country. Its self-operated distribution trucks ply approximately 500 routes servicing 63,000 customers in 48 states and are replenished from 117 branch warehouses located throughout the nation.

FARM boosts of industry leading product development, roasting, sustainability, and risk management capabilities in both specialty and cost competitive coffees, which helps to attract coffee-centric partners looking to elevate their coffee programs. Its significant new accounts in 2012 included Wyndham Hotels and Resorts, Walgreens, Hannaford, Ramada Hotel, Days Inn Hotels, Howard Johnson Hotels and Sweetnay Supermarket. At its 2012 annual meeting, FARM acknowledged that it does have a working relationship with McDonald’s, but was unable to offer more details. FARM is not resting on its laurels and launched a new line of specialty coffees, the Artisan Collection by Farmer Brothers and Twinings premium teas in September 2012, to gain market share in the fast-growing premium and specialty sectors of the market.

Valuation and Financial AnalysisSince FARM has been in losses for the past five fiscal years, P/E and EV/EBITDA valuation multiples have no significance here. It currently trades at 2.9 times P/B and 3.2 times P/NTA, representing premiums of 93% and 88% over their average five-year values, respectively. FARM's share price has almost tripled since its trough in September 2011. Two analysts polled by Reuters expect FARM to record profits in fiscal years 2013 and 2014 ended June.

FARM Historical P/B and P/NTA Multiples1360912392869.png

FARM Historical Book Value Growth1360912441736.png

FARM has a dismal profitability track record with losses in six out of the last ten years. Its cash flow generation is much better with negative free cash flow in only two years (fiscal 2005 and 2010) in the past decade. Its lackluster profitability is partly attributed to the state of the foodservice industry which fell on difficult times with the economic downturn and many of FARM's customers went out of business. FARM's gross profit margin has been on a severe decline over the years. FARM is focused on controlling operating expenses, and it reduced operating expenses by $30 million in fiscal 2012.

FARM Earnings-Cash Flow Comparison 1360912916762.png

FARM Profit Margins Analysis1360912956781.png

Financial and Business RisksInventure is moderately geared with a gross debt-to-equity ratio of 55%. Prior to 2012, it was debt free.

FARM Cash-Debt-Market Capitalization Comparison1360913254822.png

In fiscal 2011, from July 2010 to June 2011, the market for green Arabica coffee, FARM's primary raw material, increased approximately 80% per pound compared to the prior fiscal year, but has declined materially since September 2011. Coffee commodity costs have retreated more recently, providing better margin opportunities. FARM has instituted a hedging strategy to “lock in” some of its future coffee purchases, which will provide more margin stability going forward.

FARM does not have significant customer concentration risk, as it serves a wide variety of customers, from small restaurants and donut shops to large buyers like restaurant chains, hotels, gourmet coffee houses, national drugstore chains, large regional and national grocery and specialty food retailers. No single customer represented a significant concentration of FARM's sales in fiscal 2012.

ConclusionIf coffee markets remain stable, FARM is likely to return to profitability in fiscal 2013. However, valuing FARM is tricky and it will be a huge leap of faith for value investors to enter at current valuations.

DisclosureThe author does not have a position in any of the stocks mentioned.

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Mark Lin

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