Wednesday, December 7, 2011

Farmer Brothers: The Coffee Stock That Was Left Behind.

When looking at stocks, generally, my favorite ideas revolve around some form af accounting that the market doesn't seem to fully understand. Whether it is people going crazy about debt covenants and capital lease obligations at Steak 'n Shake, or moaning about Sym's never having a distribution of assets to shareholders to notice that their real estate was understated on their books- odd and out of favor companies are my favorite ideas... period.

I think that Farmer Brothers meets this description. Oddly, it's one of the few stocks that I can think of where the company is trading at a lower price than it was in March of 2009... in fact it presently trades within 50% of the level it was when the bottom of the market fell out, despite a recent run up in the price! In fact, it seems like this is the only coffee related company that has not reached astronomic levels of valuation in the past few quarters (cough* JVA & GMCR *cough cough). Shadow Stock originally did a post about the company, but, it has been a while, and the site is now down.

Here are some of the reasons why I am happily long FARM.

Coffee Is Addictive: I like that the company peddling the last addictive product that you can ethically and legally sell to teenagers. Furthermore, there aren't really any substitute items for coffee, so, end consumers should be pretty price insensitive. Certainly, these reasons alone are not enough to buy a stock, but that said, I do generally like the industry.

Low Float & A Lot Of Shares Short: Insiders own a ton of the company. According to Yahoo! Finance, ~86% of the company is owned by insiders and mutual funds; while that number is not necessarily important for the sake of people holding on to their stock, the controlling family owns roughly half of outstanding shares, and an employee stock plan has another ~14%... When high insider ownership is combined with some bigger mutual funds such as Franklin Resources, the float is quite low, so, it wouldn't take very much to make there be a huge movement in the stock... This is especially true with a short ratio that is presently above 10 (per Yahoo! Finance). I would argue that may be what has caused a lot of the recent run up in price.

Insiders Are Buying: By my count, since March of this year, well in excess of 35K shares of stock have been bought by insiders. Additionally, the dollar amount of those purchases was just shy of a quarter of a million dollars (net of a single sale); a not insignificant amount when considering the relatively small market cap of the company (under $100 million). This ratio of shares bought gets even more impressive when looking at the float of the company.

Understated Coffee Inventory: Have you ever wanted to do something similar to what Warren Buffet did with cocoa beans in 1954 (go about 3/5 of the way down to read the story)? Well, this is kind of an indirect way of doing so. I say this, because due to LIFO accounting, the recent dramatic increases in coffee prices, and the subsequent reserves that have been created on the company's balance sheet, their coffee bean inventory is dramatically understated. The quarter before last, their LIFO Reserve was an astounding $70 million dollars!

With this inventory, if prices of coffee continue going up, it will make earnings look bad, but, will effectively give the company a tax benefit, as they get the time value of NOT paying taxes on the increase of the value of their inventory. If prices fall, then that will decrease the value of their coffee, but, make their earnings "look" a lot better as they write down the reserve, which would likely sway investor sentiment to the company and give management something to tout. Don't believe me? Check out this explanation of LIFO accounting.

Additionally, if coffee prices would fall, I would imagine that the company would be able to use sticky prices to increase it's profitability...

A Glut Of Owned Real Estate: The company has a lot of real estate... PP&E is on the books for $108.7 million. Looking at tax records, we see that the Los Angeles County Property Assessor values the company's headquarters at just shy of $40 million. While the facility has recently gone through a great deal of improvements, looking at the tax data, the most recent of the improvements (the actual buildings) have been up since 1964... As such is the case, I can't imagine that the old improvements are on the books of the company for very much money (if anything). If that isn't enough, the company owns 45% of it's facilites, which mainly consist of warehouses that I would imagine would be readily salable if the company needed cash or had to liquidate. They range in price from a few hundred thousand a piece, to a few million. I feel quite confident that a lot of their PP&E on the books is justified by real estate, and that if anything, their assets are dramatically understated...

As have seen with Dewey Electronics in the past, old PP&E is a friend of the value investor. Especially if it is real estate that can be sold (well, in that since, not totally like Dewey). Warehouse facilites which are presently storing food product, should retain value pretty well, as they probably will be in decent sellable condition if need be. Farmer Brother's, as well Syms, a lot of the real estate is pretty spread out (even if it is in California), which eliminates some degree of geographic risks. 

A Possible Turn-Around: The company is in the midst of a turnaround effort... Never a bad thing. 

Even If Things Don't Work, I Should Be Safe: While it is certainly way too early for me to declare victory in regard to my previous statement on Syms: "Maybe I'm missing something along the line of earnings and cash burn; even if the company does manage to go insolvent, there there still seems to be little reason to worry." I am willing to make a similar statement with Farmer Brothers. Due to all the real estate on the books and the coffee bean inventory, I feel pretty safe from any near term insolvency issues, which, if the cash burn of the company again accelerates, may become an issue.

Conclusion: So, here, we have a company in an industry that I like, that is trading below a dramatically understated tangible book value, that is also turning around? Wow.

Disclosure/Disclaimer: I am long shares of Farmer Brothers and Syms. I do not own any other shares of the companies mentioned. I reserve the right to change any of my positions at any time. This is not advice of any kind. Always do a ton of your own research in regard to anything that I say, do, write, or so much as even think about.

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