Is Keurig Green Mountain’s Share Buyback Program a Good Deal?

By Sean O’Reilly

Buffett on Buybacks

“There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds -- cash plus sensible borrowing capacity -- beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated. -- Warren Buffett, 1999 Berkshire Hathaway Chairman’s Letter to Shareholders

A Rough Quarter and a Billion Dollar Buyback

• Following a less than stellar quarterly release on August 5, 2015, Keurig Green Mountain’s CEO announced a $1 billion share buyback initiative, stating:

• “Underscoring our commitment to delivering value to our shareholders, today we announced that our Board authorized an additional $1 billion share repurchase which adds to our existing plan.” -- CEO Brian Kelley

A Rough Quarter and a Billion Dollar Buyback

For the quarter ended June 27, 2015:• Gross margins continue to shrink – dropping from

43.5% to 36% year-over-year• Revenues slid 5% year-over-year• Diluted earnings per share fell 22% to $0.73• Keurig brewers and accessories net sales fell 26%• Pod net sales eased down 1%, even after factoring in

volume growth of 5%

What Would Warren Do?

Is Keurig Green Mountain’s latest share repurchase program a prime example of intelligent capital allocation, or a ploy to support the share price

after a terrible quarter?

This isn’t Keurig’s First Buyback Rodeo

FY 9/29/2012 FY 9/28/2013 FY 2014

Cost of Share Repurchases

$76.5 mil. $188.3 mil. $1.05 bil.

Not a Great Buyback Record

• Keurig Green Mountain spent a staggering $1 billion dollars last fiscal year buying back shares, while the stock was trading at all-time highs

• Now that the stock has fallen over 60% from its peak in November 2014, Keurig Green Mountain wants to go double or nothing and spend another $1 billion

Best Use of Shareholder’s Capital?

• There are fourpossible uses for shareholder’s capital:–Capital investments–Dividends– Share repurchases–Acquisitions

• Is it possible that Keurig is finally making the right move?

Best Use of Shareholder’s Capital?

• Companies should buy back their own stock when it is trading at a meaningful discount to “intrinsic value”• Intrinsic value is an inexact number, but it

is no less important because of this fact• What is Keurig’s intrinsic value?

What is GMCR REALLY Worth?

• Intrinsic value is defined as the present value of all the future cash flows that will be generated by a business discounted to the present

• Calculating Keurig’s future cash flows is extremely difficult -- its Keurig-pod business is suffering from competition, and future growth is now pinned on the Kold

• Such uncertainty requires a large margin of safety

What is GMCR REALLY Worth?

• Keurig currently trades for 15.2 times forward earnings per share according to S&P Capital IQ

• Earnings per share are expected to grow about 7% annually through 2019

• This compares favorably with the S&P 500’s current P/E ratio of 19 times

• Keurig’s future results could deviate WIDELY from these estimates

Foolish Bottom Line• Keurig trades at a modest discount to the rest of the

market• It faces severe headwinds and uncertainty• It should be trading at a discount to the broad market• This repurchase is being done in order to avoid

hypocrisy in the face of previous enormous buybacks, just as much as it is to “return capital to shareholders”

• The share buyback is, at best, a wash for shareholders

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