Coffee Holding Co. JVA

Way down among Brazilians 
Coffee beans grow by the billions 
So they've got to find those extra cups to fill 
They've got a zillion tons of coffee in Brazil…

The Coffee Song (They've Got An Awful Lot Of Coffee In Brazil) / Frank Sinatra

Coffee stocks have been getting a lot of investor attention lately, with names such as DDRX, GMCR and SBUX generating stunning returns for investors.  The company behind the Dunkin’ Donuts brand has an IPO in the works.  There are even at least two coffee ETFs, the iPath Dow Jones-UBS Coffee Total Return Sub-Index ETN, ticker symbol JO and the iPath Pure Beta Coffee ETN, ticker CAFE. 

With all that attention you’d think the sector was probably overvalued.  There’s even a highly promoted pump and dump candidate, Jammin’ Java (JAMN) eloquently written up as a short-sale trade by fellow VICer “unkown345” assisted with Spy Magazine quality messages (that’s high praise, folks) by VICer “snarfy”. 

But in that pail of over-roasted beans there’s a high quality green Arabica nugget that hasn’t yet reached its peak of perfection.  This microcap shot of espresso goes by the unglamorous name of Coffee Holding Co., ticker JVA.  What makes this little-company-that-could-so attractive?

·         2^nd highest top-line growth in the sector (20.1% QoQ revenue growth in the latest qtr, more than twice that of the comps median; second only to GMCR)

·         Revenues have grown an average of 13% per annum in the past four fiscal years and operating income has grown 31% per annum in the past four fiscal years.

·         Highest free cash flow yield in the sector (6.7% compared to 3.1% median for comps)

·         Lowest EV/EBIT multiple in the sector (9.6x, which is slightly more than half the comps median of 18.6x)

·         2^nd lowest EV/Revenue multiple in the sector (.86x compares to 1.83x comps median)

·         Lowest forward P/E in the sector (10.3x compared to 19.1x median for comps)

·         One of only two companies in the sector that pays a dividend (the other being SBUX) and has the highest dividend yield in the sector (1.53%).

All of the above is true despite the recent run up in the price since the outstanding Q1 results.  Q2 results are expected out on June 6^th.  In this write-up I look at JVA in relation to other pure-play coffee companies.  The comps I focus on are JAMN, FARM, PEET, CBOU, SBUX and GMCR.  I do not include diversified companies such as KFT, P&G, SJM, etc.

Overview

Coffee Holding Co., Inc. is a Staten Island, NY-based integrated coffee roaster and dealer that has been a family operated business for 40 years.  The Company was founded by Sterling Gordon in 1971; he is the father of the current executive team, Andrew Gordon (CEO/President/CFO) and David Gordon (EVP and COO).  The brothers have been working with the company for 28 and 30 years, respectively.  The Gordon brothers own 42.7% of the Company’s stock between them.  Their parents (Sterling Gordon & Rachelle Gordon) own 6.6% of the Company’s stock, so they all have a lot of skin in the game.  The Company went public in 2005 at $5 per share. 

Products fall in three categories: Wholesale Green Coffee, Private Label Coffee, and Branded Coffee.  The Company also has a food service business. 

Wholesale Green Coffee – this is the sale of unroasted beans from around the world that are sold to coffee roasters and coffee shop operators.  These include over 90 specialty coffee offerings, including Organic, Fair Trade, Rainforest Alliance and Utz Kapeh certified coffees. 

Private Label Coffee – coffee that’s roasted, blended and packaged by JVA and sold under the specs and names of others, including supermarkets that want to have their own brand to compete with national brands.

Branded Coffee – coffee roasted and blended to JVA’s own specifications and sold under the Company’s seven brand names in different segments of the market.  Brands include S&W Premium, Café Caribe, Via Roma, Café Supremo, Fifth Avenue, and Don Manuel.  The company recently discontinued its Entenmann’s brand. 

The Company has coffee processing capacity in Colorado and Ohio.  The Colorado facilities are located in La Junta and Rocky Ford.  The Company’s Ohio capacity is through its 60% ownership on Generations Coffee Company, LLC located in Brecksville, which is a JV set up in 2006 with Caruso’s Coffee, Inc.  The company sold its Brooklyn, NY location in October 2009 which reduced long-term operating expenses. 

 Green Mountain Coffee Roasters is JVA’s largest wholesale green coffee customer.  And while it operates without any formalized material agreements or long-term contracts with GMCR, it has an 18 year relationship with Green Mountain.  Sales to GMCR accounted for 47% of JVA’s net sales for the FYE October 31, 2010, up from 35% in 2009 and 32% in 2008. 

The Company’s growth strategy is based on selective acquisitions and alliances, targeting the growing Hispanic market, increasing penetration to existing customers, and developing the food service business. 

The JV with Caruso’s Coffee is an example of a successful alliance.  This JV has allowed the Company to pursue private label business, which it wasn’t in a position to pursue before the JV.  The May 2010 purchase of Organic Products Trading Company (OPTCO) is an example of a successful acquisition.  The Hispanic market is targeted with the Company’s Café Caribe and Café Supremo brands.  Increasing the Company’s penetration with existing customers is being accomplished by adding new brand names and products including specialty blends, private label value blends, specialty instant coffees, instant cappuccinos and hot chocolates, and tea line products.  The Company’s presence in the food service market is small, but growth is targeted by marketing to hotels, restaurants and office coffee service companies and by attending trade shows to build a national audience to market its food service products. 

After trading in a range for a number of years, the price of commodity increased dramatically starting in June 2010.On June 10, 2010 the near-term Coffee “C” contract for the benchmark Arabica coffee (KCA Comdty on Bloomberg) traded at a price of 140.35 (cents) per pound.  By the end of 2010 it was 240.65 and peaked at 305.15 on May 3, 2011.  It has since come off to 263.70.  Robusta coffee generally trades at 70% of the price of Arabica coffee.  The Company has generally been able to pass green coffee price increases through to customers.  In addition, JVA uses coffee futures and options to partially hedge against the effects of changes in coffee prices.  Profits and losses (realized and unrealized) from hedges flow through the cost of sales line.  Despite the hedges, the Company says it remains exposed to losses when prices move up or down significantly in a very short period of time.  

Sales increased 12.1% in FYE October 31, 2010 due to higher prices and an increase in pounds sold.  In the latest quarter (ended January 31, 2011), sales increased 20%, also reflecting higher prices and additional poundage sold.  Part of this increased quantity sold was a result of the OPTCO acquisition completed in May 2010.

The table below shows the financial performance of the company from FYE October 31, 2007 to the latest 12 month period.  I prefer to look at successive LTM periods to remove the impact of seasonality.

Valuation

The valuation table below highlights how cheap JVA is compared to its coffee peers on a number of metrics.  On EV/revenues, JVA is cheaper than all but Farmer Bros, which is a perennial loss maker, even at the operating income line.  

On EV/EBITDA and EMC/Net Income (P/E), JVA is cheaper than all but Caribou Coffee, though JVA is cheaper on than all on forward P/E (and it’s at half of Caribou’s forward P/E).  On FCF Yield it’s cheapest by far, and has nearly twice the FCF yield of its next closest coffee comp, SBUX. 

While its margins are lower than those of its peers, I believe this has something to do with sale since margins almost universally appear to be higher with sales.  Interestingly, with JVA’s low CapEx requirements and low D&A, its FCF as percentage of revenue is in the middle of the pack.

Liquidity

Another point worth mentioning is JVA’s net cash position.  Cash on the balance sheet exceeds the modest amount drawn under the credit line.  JVA’s cash generation is highlighted by the fact that it’s one of only two of the group that pays a dividend (and it’s got the highest dividend yield in the group). 

I believe as JVA carries on with its strategy of selective acquisitions, growth through targeting the high growth Hispanic market, increased penetration of existing customers and expanding its food service business, its number will continue to improve and the stock will continue its ascent.  While it’s had a nice run since earnings were released in March, it still has room to run, as highlighted by the valuation table above.